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332.4 - Loans Secured by Government (1944 - 1954. Obligations Discount Rates - Operations of FRBanks n o '• . TRASftI • I (tin. Form F. R. 567 END SHEET KIND OF MATERIAL OR NUMBER 332.4 NAME OR SUBJECT Loans Secured by Government Obligations Discount Rates - Operations of FRBanks DATES (Inclusive) 1944 — 1954 PART NUMBER 3 11.C4J 13 J i r I livo or.gu I MAY 8 1953 May b, :Jovernor I7ymczak ,ovrnment Advances on - r. Vest I attach E. memorandum which explains historically the situation with respect to advances by Federal Feserve FanKs to member banks for periods up to 15 days or for periods up to 90 days. , ' As you Know, on, of the matters beinc considered in connection made of the discount function and mechanism is with the study now being ; what chanes, if any, miir,ht be desirable in FeL ulation A under present this connection, of course, the provisions of the circumstances, and in , e'.ulation with regard to 90-day advances on Gov. rnments need special indicated Ln the attached mcmolandum, if it should consideration. As be decided to make a change on this point it could be done either by prescribink; a higher rate for 20-day advances on GovPrnmnt securities then on 15-day advances, as was the situation prior to 139, or the Roard might even go co far as to state in its Feculation that no ad?rnment obligations shall be vances to member or nonmember banks on Gov, in excess of 15 days. made for a period Thinkin that perhaps the information contained in this memorandum may be of some interest to you as backroun6 material on your present trip, I have asked lr. Vade to be good enough to forward it to you. Attachment 3V: urn klN fttC'D rilits secrionl MAY 8 1953 ADVANCES TO MEMBER BANKS ON GOIURNMENT OBLIGktIONS- The Law. - Under the original Federal Reserve Act, Federal Reserve Banks were authorized to discount commercial paper or paper for the purpose of carrying bonds and notes of the United States, with maturities up to 90 days (or aricuitural paper with maturities up to 6 months). In 1916 Federal Reserve Banks were authorized to make advances to member banks for periods not exceeding days when secured by eligible paper or bonds and notes of the United States. By the Banking Act of 1933 Federal Reserve Banks were authorized to make advances secured by eligible paper with maturities up to 90 days. All discount transactions are under the law subject to regulations, restrictions and limitations by the Board of Governors. The last paragraph of section 13, which was added by the Fmergency Banking Act of March 9, 1933, authorizes the Reserve Banks to make advances to any "individual, partnership or corporation" on notes secured by direct obligations of the United States. Such advances are subject to such limitations, restrictions and regulations as the Board of Governors may prescribe; they may be made for periods not exceeding 90 days; and they bear interest at rates fixed from time to time by the Reserve Banks subject to review and determination by the Board. Two days after .he last paragraph of section 13 was added, thet is, on March 11, 1933, the Board ruled in a telegram to all Federal Reserve Ranks that the word "corporation" in that paragraph includes banking institutions, whether members or nonmembers of the Federal Reserve System. Teis position was reaffirmed in a telegram to all Federal Reserve banks on Seytember 13, 1939 in which it was made clear that the last paragraph of section 13 authorizes advances to member banks on Government obligations for periods up to 90 days, notwithstanding the 15-day limitation on advances under the eighth paragraph of section 13. Regulation A. - As indicated above, since 1913 the law has authorized discounts of commercial paper or of paper issued for the purpose of carrying Government securities, with maturities up to 90 days; and Regulation A has, of course, reflected this situation. With respect to advances as distinguished from discounts, the Board's Regulation A, as revised in 1937, in subsection (b) of section 2, headed "Advances on Government Obligations", stated that advances could be made under the authority of section 13 to any member bank for periods not exceeding 15 days on the note of such bank secured by bonds and notes of the United States. However, the regulation at this point contained a footnote calling attention to the fact that under the last paragraph of section 13 a Reserve Bank niblit make advances for periods not exceeding 90 days on Government obligations to "individuals, partnerships, or corporations (including banks)". C re.r. k. iti;;Callocii -2 - Apparently because the text of the regulation seemed to authorize advances on Government obligations only up to 15 days, there was some confusion and uncertainty on this point among memeer banks. In order to clarify the question, the Board published a statement in the Federal heserve Bulletin for ,:arch 1942„ page 207, stati ng in effect that Federal Reserve Banks may make advances both to member banks and nonmember banks on their promissory notes secured by direc t obligations of the United 3tates for periods not excee ding 90 days. The point was further clarified by an amendment to -egulation A adopted on 'arch 20, 1942, which changed subsection (b) of secti on 2 so as to provide expreselyi that a Reserve hank may make advan ces to member banks on 1overnment obligations for periods not excee ding 90 days. A footnote to this provisiod explained that the eoard had const rued the term "corporation" in, the last paragraph of section 13 as including any incorporated bank. Rates. - Before eeptember 1939, the rates fixed for advances on Government obligations under the last paragraph of section 13 were from 2 to 2-1/2 per cent higher than the regul ar discount rate) and these rates applied to all advances under that paragraph, whether to member banks, nonmember banks, or nonbank borrowers. In other words, a member bank borrowing on Government oblig ations for 90 days under that paragraph at that time was required to pay a higher rate of interest than the regular discount rate. Thus, in August 1939, the regular rate at the Federal Aeeerve Bank of r1ew York for discounts of eligible paper was 1 per cent, while the rate for advances on Government obligations under the last paragraph of section 13 was 3-1/2 per cent. The rate Zor advances under section 10(b) was 2 or cent. In this connection, Regulation A at that tirde as at present) provided that the rate on section 10(b) advances should be not less than one-half of 1 per cent higher than the highest rate applicable "to discounts for member banks under tne provisions of section 13 and 13a of the Federal Reserve Act". Justification for having a rate under section 10(b) which was lower than the rate charged member banks on advances under the last paragraph of section 13 was apparently based either (1) on the fact that when the requirement for a rate on section 10(b) loans higher than "the highest discount rate" was put into the law the authority for advances under the last paragraph of section 13 was not in existence, or (2) on the theory that the discount rate specified in section 10(b) refers only to discount transactio ns ind not to interest rates on advances. On 6eptember 1, 1939„ the board announced that the iieserve Banks would make advances on Government oblig ations to member and nonmember banks at the rates prevailing for member banks. At the sage time, the rates were lowered so that after eeptember 193), both member and nonmember banks could borrow for 90 days on Government obligations -3- at a rate of from 1 to 1-1/2 per cent. In October 1142, member banks, but not nonAember banks, were given a preferential rate of one-aalf of 1 per cent with respect to advances on Government obligations callable or maturing within one year. The rate on advances on all other Government securities was fixed at 1 per cent for both member and nonmeber banks. This situation continued throughout the war until the Spring of 1946, when the rate on advances to nonmember banks under the last paragraph of section 13 was made the same as that on advances to nonbank borrowers. At present, this rate is from 2-1/2 to 3 per cent at the various Reserve Banks, as contrasted with the regular discount rate (and the rate for advances to member banks on Governments) of 2 per cent. Possibilities. - If it should be desired to discourage or prevent member banks from borrowing on Government obligations for 90-day periods, it seems that this might be done in at least three different ways. 1. The Reserve Banks might be asked to look with disfavor upon any application by a member bank for a 93-day advance under the last paragraph of section 13. The making of advances by the 3eserve Banks is not mandatory but discretionary; and section 4 of the eederal deserve Act, as well as the general principles stated at the beginning of Regulation A, require the deserve Banks to have due regard to the maintenance of sound credit conditions in extendinL, credit accommodations to member banks. If this approach were taken, however, it seems that, to be consistent, the Reserve banks should also look with disfavor upon an application by a nonmember bank for any advance on Government obligations for a period in excess of 15 days. 2. Since advances under the last paragraph of section 13 are subject to such "limitations, restrictions and regulations" as the Board of Governors may prescribe, it would be possible for the Board to take the position, either by an amendment to Regulation A or otherwise, that no Federal Reserve Bank shall make any advance under that paragraph for a period in excess of 15 days. Again, if this should be done, it would seem that the same limitations should apply to advances made to nonmember banks. 3. The rates (from 2-1/2 to 3 per cent) on advances under the paragraph of section 13 which are now applicable to nonmember banks last and nonbank borrowers could be made applicable also to member banks, as was the case before September 1939. 5-3-53 HHH:GBV:lim H REVD IN FILES SECTION NOV 6 1952 November 6, 1952 (Jeneral Files Mr. Shay n, Authoritylor administrative change in limitation on bank loans secured by Uoverneent obligations. In connection with the re.tter aiscussed in rv waltaacluln_tta. l GeneralF4es of November i952 a eurther inquiry was raised as to 114 sc6pe o, tn.u. authority oilhe Comptroller of toe Currency and the Secretary of the Treasure under 5200,ta, to change the statutory percentage limitation on bank loans see urea by uovernment obligations. That teere is administraeive aujiority to relax or remove, but probably not to tizheen, such statatory percentae limitation is eiscuseed below: Basic limitation, exception, and auministrative authority to cnange. - In general, tee total eeligations to a national bale of any one eerson are limited to 13 per cent oe the eane's paid-'in capital stock and 10 der cent of its unimpaired surplus fund. Among the exceptions t. this general rule is one applicaele to u[o]bligations * in the form oi notes securea by not less tean a like amount of" oeli,,ations of the united ::tates, in which case the obliations‘of any one person "snail (except to the extent „permitted by rules and regulations prescribed ey the Comptroller of tee Currency, with the approval of true Secretary or the Treasury) be subject ... to a limitation of 15 per centum of such capital ana surolue in addition to such 10 per centum oi such capital and surplus". (Emphasis added) A.S., 5200, t(3) Deibtful weether_peecente in statutory exception may be tightened administratively. - 2o11owinc; an inquiry concernin,, the scope oi the authority of the Comptroller and the Secretary under the parenthetical clause in the exception quoted above, Ar. eexter, in the Comptroller's Legal Livision, indicated teat, in his view, the Comptroller woeld not take the position twit he had authority to reduce the statutory maximum percentage limitation in the exception. I gathered urom my conversation with kl.r. eexter, hoieever, tnat the authority to reduce such limitation probably has not been a matter subject to formal determination by the Comptroller. Percentage limitation ma_ be relaxed or removed administratively. On the other hand, that the Comptroller anu the Secretary have regarded such authority as authorizing the establishment of a limieation in excess of that stated in tee exception is indicated by the fact, related by ;Ir. dexter, that a 45 per cent limitation established by aaministr ative 1•1 ueneral Ales -2- action was withdrawn on Septefaber 30, 1924. Although he was s)mewnat hesitant about it, Mr. Jexter seemed to thire. that the Comptroll r and the Secretary could go even further and permit, without any limitation, loans secured by ',government securities. The provision in section 11(m) al the Pederal Reserve Act exemptin6 ban:. loans secured by Uovernment obligations from the 10 per cent limitation on loans secured by stock or bond collateral, and making loans secured by uovernment obligations "subject to same limitations and conditions as are applicable in the case of national banks" under R.S., 200, t(3), was added to t_le law by the banking Act of 1935. In connection w._th the preparation o_ this 1935amendment to section 11(m), it appears that the loard's General Counse l supiaied the Treasury Department wit a proposed amendment to section 11(m) which would have exempted, without any limitation, loans secured by Governnent obligations. (See Mr. Wyattls letter to don. Tom:,. Treasury Department, May 1d.c 1934): However, from a memorandum pf . May 23, from the '60117-driltieneria Counsel to Mr. Opper in tie Legal -DiVi Sion of the i'reasury, it appears that the Treasury favored a limitation on the exception in the form contained in section 11(m) as finally amended by the iiankim] Act of 1935. In suggesting, in effect, that the Treas,xy's proposal was unduly speciiic in so tying al(m) to t(a) of V5200, the board's (Jeneral Counsel said that "as I understand the provisions of paragraph (:)) of section 5200 . . it authorizes the Comptr oller of the Currency with the approval of the Secretary of the Treasury to prescribe regulations permitting national banks to loan more than 25 per' centum oi their capital and surplus to sinle borrowers on tie security or Government obligations .. . even to remove or entirely tAe limitations on the amount wlich may to loaned to one custom er on such security. If this is correct, the Comptroller . . . could issue regulations which would remove any advantati,e which a,ate member bans "iitit:lave over national bans under our draft of the ;)roposed amendment Lejislative history of section 11(m) not helpful. The Congressional Committee Reports on tne ...linking Act of 1935 shed no light on the question of the scope of the authority of the Comptr oller and the Secretary to change the 22 per cent limitation. Such _teport s merely indicate a purpose "to extend to State member -ans the provis ions applicable to national barn:1s w.dch enlarges the maximum limita tion on loans to one individual from 10 percent • • • to 25 percent • • •" (Senate lieport No. 1007, 74t, Cong., 1st Seas.) "so as to place State member banks on a parity with national banks in lending on the security of" Government securities (douse Report No. 742, 74th Cong., 1st Seas.). emb 1 November 3, 1952 :tank 1o1$1;GOSUMTMV$S44NrrION bank )vrcolases ilf4Mited Government ob1istationk0V Stat 5 n2 Mr. Shay 31. , A :NJestior recently was raised resardins the limitations on banS loans coilateraled by United States uovernment securities and also on banx purcases of 6ovsrnlent securities. in the case oS sarcsa ses, the question involved the status of the transaction where, for exasple, the surchasins bank had the right to rcy4uire t:le toe nec.urities to repurcnase them from the bank. Loans secured by. - Briefly, A. S., 5200, ( J), provides that g( the total "[01b1iations of any person .. ." held by a national ban's "in the form oi notes secured by not less than a like amount of' , Government securities Niay not exceed 25 per cent of t.;10 sank's "capital and surplus". :Chia is an exception to the standard limitation of 10 per cent of capital and ssrplus on the total obligations of one person that a nation al bank w.ay hold lawfully. By section 11(m) of the iederal Heserve Act, State member Lanka, in the case ol "loans represented by Obliaations in the form of notes secured by not less than a like amount of" Government securities, are suSilect to "the same limitations and conditions as are apslicasle in the case of national banks under" WOO, t(3). Thus, in the cases of Soth national and State member banks, the sane hishsr losn limit, i.e., 25 pr cent of capital and surslus, is permissiiae wire the obligation or loan is "in the form of notes secured by rot less than a like amount of" Government securities. Investment in or purchase of. - So far as national. banks are coscornes, restrictions on and permissible types of investments are coveres by A.S., , . 5136, Seventh. oriefly, securities purchases Ly national banks for their own accsunts are limited to purc-ases of ''investment securities under such limitations and restrictions as tne Cosistrollsr of the Currency by regulation prescribe". fho Comptroller, by reisulation, may also implement tac statutory definition of "investnent securities". ;iowsver, in no event may a bans hold "inves tment securities" of any one oblisor or maser In as asunt in excess of 10 per cent of the paid-in casital stock and 10 per cent of the unimpaired surplu s fund of the bank. An exception in the statute provides that "[Ole limitations and restrictions herein cset.ained as ts .:ealins in, underwriting and purchasins for its own ace tint, investment secarities shall not epsly to obligations of the k:nited ,taes .. ." - 1 General 2iles The Federal Reserve Ace, 9, i20, provides that "State member banks shall be subject to the same limitations and conditions wita respect to the purchasing, selling, underwriting, and holding of investment securities and stock as are applicable in the case of national banks under" R.S., t5136, t Seventh. Here also the apparent intent is that national peaks and State member banks &iall e on a basis of equality. Repurchase arrangements. - ior the perpoees hereof, it is assumed, for example, that a clealer in J. 3. Go_rnment securities desired a bank loan, collateraled by such securities, in an amount greater than the national bank to which he applied for the loan could lend to him under the 25 per cent limitation in H.S., 0200, '(i). therefore, the bank agreed to purchase from the dealer Government securities in an amount sufficient to yield the sum whicn the dealer had desired to borrow. At the same time the bank and the dealer agreed that the bank would have an option to require the dealer to purchase back from the bank Government securities at a price in no case less than the market value of tne securities at the time of repurchase. Ile dealer had no right or option to require the bank to sell to aim. Briefly, the view of the Comptroller of the Currency is that the transaction just described would be permissible, without limitation, under the exception in R.S., 0136, t Seventho mlating to bank investments in obligations of the United States. In saca a case it is the Comptroller's view that the purchase by the bank is merely rendered a more attractive one by virtue of the bank's option, and that the favorable nature of the entire transaction to the bank is such that it is not, by virtue of the repurchase arrangement, rendered any less an investment of the kind permitted without limitation. However, repurchase arrangements in connection with bank purchases of Government securities whica would be less favorable to the bank would prevent qualification for the exception in H.S., 0136, t Seventh, and would ue regarded as illegal under that statute. This would be the case where, for example, the person who sold the Government securities to the bank had an option 2pinionsl Comptroller of against the bank to repurchase. See Dijest of_2 r the Currency, '630; Investment Securities Reip ulation of the Comptroller of the Currenc7, 12 C.F.R., Ch. 1, Pt. 1, U.2(g) and O. Furthermore, certain other so-called repurchase arrangements which would cause the transactions to be disqualified for the exception in A.S., 0136, S Seventh, would be regarded by the Comptroller as actually collateraled loan transactions. It is understood that this would ue the case where, for example, the seller of the Government securities had the right to repurchase, and the bank had the right to have him repurchase, at the same price for which the bank '1:urchased the securities from him. In such a case, it General 14' iles would seem doubtful whether the validity of tie transaction oui 2001 i.e., "notes be established under the language of a*S., ? secured by", even trouh the sum supplied y the bank to the ,o11,A4 would te within the 2, per cent limitation of that statutory provision. Certain 3-tate limitations on loans and invextInents. inquiry in this connection Also mentioned th1.3 possibiltty that .certain State laws might prevent or restrict rcriurc.Aase arrangemenLs o AaLe banks of th type that would '.43 oermisible to national h7TikE as indicated above. The States mentioned were New York, Pennsylvania. :*lassac'flusetts, Illinois, and (.!lifornis. The statutory limitations on han',?.. loans t:; one person secured by Government securities and tne statutory authority of banks to purchase Government securities in these Sta-es are taLulated below*: "Joan Limitation (per cent of capital stocK and surplus) New York 25 per cent - if 15 per cent fully secured i'ensylvania Apparently unlinited - if fully secured Massachusetts 25 per cent - if 10 to 15 per cent fully secured dependinc on si2e oi bank Illinois ,.;/") per cent - lf fully secured Cal i:cortlia nlirtcd - If valae of collateral oxcecds loan by 10 per cent rurchase Authority Unlimited It II o in4o the matter :Lae staLut4Soi tz,tlse -tates do not appear o of repuretlase arrangements such as those discussed nerein, and the attitudes of tt.c tate supervisory auttorities are unicnown. Aowever, it is to be noted that none of the rtates appear to nave provisiens lore restrictive than those ap: Jiicacic to national ban.s, except possibly California. New York bankin6 Law, Art 3, 'J)3; Purdon's ?onLa. Stats. Anno., 11..lOO6j Anno. aws of .1:158., Ch. 172, ,.33, 43; L:itn-A,rds title 7, Illinois Anno. State., Ch. 16-1 21 JO; DeeriL6Is alif., Code, Anno. / Av. 1, Ch. 1). ,1207$ 1226 and Ch. 11, C • •AP- PP A . LES09r FEDERAL RESERVE BANK OF DALLAS oECU 1952 • R.R.GILBERT PRESIDENT October 28, 1952 Mr. Sam R. Carpenter, Secretary Board of Governors of the Federal Reserve System Washington, D. C. Dear Sam: In view of our recent telephone conversation regard— ing the borrowing of one of our large member banks, I thought that you would be interested in knowing that after discussing the matter with our Executive Committee, we advised the presi— dent of that bank that MB did not regard the borrowing as being a proper use of Federal Reserve credit, and that we would like to have the indebtedness liquidated at its maturity, pointing out that we would be willing to grant another short renewal if he could not conveniently arrange to pay the loan when it matures. The president of that bank fully understands and ap— preciates our position in this matter and has agreed to comply with our request. With very best pers,)nal regards, I am, Sincerely yours, R. R. Gilbert President • RIEC'D IN FILES sEcno DEC 1 I 1952 FEDERAL RESERVE BANK OF DALLAS R.R.GILBERT., October 22, 1952 PRESIDENT Mr. S. R. Carpenter, Secretary Board of Governors of the Federal Reserve System Washington, D. C. Dear Sam: In keeping with your recent request, I am enclosing three application forms which are used by the member banks of this district in applying for advances secured by U. S. Govern— ment obligations. I believe that this form is quite similar to the one being used by the Federal Reserve Bank of Chicago, which bank, I understand, has been using it for several years. Our Executive Committee is scheduled to meet tomorrow and at that time I expect to discuss with the members thereof the case I talked to you about in our recent phone conversations. I appreciate the information you gave me during those conversa— tions, which fully confirms the conclusions reached by the offi— cers of this bank as the result of their studies and discussions of the matter. With very- best personal regards, I am, Sincerely yours, R. R. Gilbert President • • REC'D IN FILES SECTION DEC 1 1 1952 APPLICATION FOR DISCOUNT OF BILLS PAYABLE Date 195 To the FEDERAL RESERVE BANK OF DALLAS: We hereby make application for the discount of the enclosed bills payable in the amount of $ authorized to charge the obligation to our reserve account at maturity. THE PROCEEDS OF THIS APPLICATION ARE REQUIRED FOR 1. 2. 3. 4. You are Deposit Decline Loan Demand Retiring other Indebtedness Other (specify) instructions regarding proceeds, or special comments: The liability of this bank for borrowed money, exclusive of this applicati on, is as follows: To Federal Reserve Bank To Others TOTAL OTHER ITEMS, as at the close of previous business day, are as follows: Total Loans and Discounts Government Securities Owned Total Deposits (Name of Bank) By (Signature of Authorized Officer) (Title) IN DEC . 71n-"scr.:„' 1 1 1952 I October-12157 -1952 Files Mr. Carpenter On Friday, October 17, Mr. Gilbert, President of the Fed,ral Reserve Bank of Dallas, called me on the telephone to discus a situation that had developed at tneir bank. He said they had discusseu several times at the bank and in meetings in Washington tae question of banks borrowing from the Federal Reserve bank against Government securities for the purpose of broadening their tax base. He said they had turned down an application for a $5 million loan recently where the bank frankly admitted thqt the purpose of the loan wa to broaden its tax base. He also said that in June the National Bank of Coemerce of iiouston borrowed $10 million and in July borrowed an additional t5 million, all against Government securities, which horrowinz had been continuoue. 1:hen the borrowing was mane, tee Feaeral Reserve Lank eed not been requiring an application indicating the purpose that tney needed the borrowing for. After the loans were male, the National Tiank of ammerce purcha,- d Government securities. J Recently, Vice ?resident Holloway, in charge of the eioueton branch, was at tne head office, Mr. Gilbert said, at whicn time the borrowin6 the National Bank of Commerce was discussed with him, eith the idea o A vhia tepe might ee taken to aecertain if the loans had been for the purpose of broadening the tax base and it was understood that when he returned to Houston he would eiscuss the matter with tne national bank with the idea that if the loans were for that purpose they would be removed at the next maturity or in any event would not be renewea more than once. Mr. Gilbert stated that subsequently Mr. Holloway rec.orted that the bank had stated that the purpose of tne borrowings was to make money, that they bought securities paying 2% or 2-3/8% with the result that the hank was earning between Z40,000 and 450,000 per year on the securities held. Mr. Gilbert also said that while the Reserve Bank was convinced that it was an improper use of Federal Reserve Bank credit they could not find anything in the law or the regulations and rulings of the Eoard which was specific enough to enable them to make the point in their discussions with the bank. He caid they had gone over section 4 of the Federal Reserve Act, Regulation A, and various rulings of the Board and could not find anything specific enough to serve their purpose and that while they did not think that the loans were consistent with the maintenance of sound credit conditions or consistent with central bank alt0-credit policy, they did not want to take the position of saying that to the member bank .dehout getting something more specific if it wee v.eilab c_2) Files -- 2 I told Nr. Gilbert that wnile I could not at the moment refer to anything more specific it had been my understanding from my early days in the System that no bank waa justi'ied in borrowing from the Federal Reserve dank for the purpose of -eking a profit on the difference between the discount rate ane the yield on the securities urchased with funds borrowed from the Federal Reserve Bank, that that was an axiomatic understanding in the ystem so far as I kne1 1 and that , the provisions of paragraph 8 of section 4 in the Board's Regulation A bore that out. I told nim, however, that I would look into the matter and discuee it a, re and would call aim back later. : I discussed the matter with Meeere. Hackley, Sloan, Solomon, Thurston, Fiefler, and Chairman Martin, and we were all agreed that such use of credit was ent:rely inappropriate for the reason stated, that if the credit were extended to one member bank for that purpose there was no reason why all other member banks should not borrow. for the same purpose, and thet furthermore the very idea of a bank borrowing for profit rather than for the purpose of meeting the legitimate credit needs of the community was contrary to the concept in the Act of borrowing from a Federal Reserve Bank and would be contrary to the monetary policies of the System. I so told Mr. Gilbert over the telepnone today. Mr. Hackley haa called my attention to tne Board's letter of Apr. 19, 1945 1 _S-843,1which grew out of an earlier conversation in October 19/,.4 with Mr. Gilbert regardina the proposed borrowinge of the City National Bank of Houston. I pointed out to Mr. Gilbert that the second sentence in the second paragraph of the letter was particularly applicable as well a:, the last paragrapn of the letter, and that tnere seemee to be no question on the basis of that letter that the borrowings of the national bank were improper. Mr. Gilbert responded that he appreciate the information and would take the matter up with his executive committee this week for the purpose of havina the loans repaid. I also inquired .whether there were any indications in the Reserve Bank that banks were borrowing for the purpose of broadening their tax base and ne said that while there probably war, some of it they were watching the matter very closely and were doing everything they could to prevent the use of Federal Reserve Benk credit for that purpose. tn response to my request, he said that e -ould end to me two copies Of the present discount application u ed by the Reserve Bank which required the member bank to state the purpose of any loan made from the Federal Reserve Bank. C ppy " 4 Advances to member banks where secured by Government obligations Mr. Gilbert raised a question as to what the policy of the Federal Reserve Banks should be with respect to maturiti es of advances to member banks when such advances were secured by Government obli gations. He pointed out that Section 13 of the Federal Reserve Act, as amended, auth orized advances against direct obligations of the United States to individuals, partners hips, and corporations for periods of up to 90 days, and that the term "corpora tion" had been interpreted to include any incorporated member or nonmember bank. He said there was a question in his mind as to whether or not it was the intent of Congress in amending the Act that the Federal Reserve Banks should as a gene ral policy make such advances to member banks for periods of more than the 15-day maxi mum provided for in the original Act. It was his own belief, he said, that it was well to have an opportunity to review such advances at least every 15 days. Several of the other Presidents said that it was customary at their Banks to make such advances for periods of up to 90 days in order to take care of the seasonal need s of smaller member banks but that most -19large bank borrowing was for peri ods of 15 days or less. Mr. Gilbert said that he had raised the question as a matter of information and not as one requ iring action by the Conference. CQ 1 cels: i'• I PA :*;EC,TION R 2 4 1(15? A 5›.-1 t' -f" MEMORANDUM March 4, 1952 To: Mr. LeonardV In reviewing the loan schedules submitted by the Federal Reserve Banks recently, we noticed that the Chicago Federal Reserve Bank and its Detroit Branch were apparently not observing paragraph (e) of Section 3 of the Board's Regulation A. It appears that in many of the cases in which the loan schedules show Government secu— rities collateral in excess of the amount of the note, the excess may arise because of the large denominations of the securities pledged. Most of the Reserve Banks, in reporting "excess" collateral in the form of Government obligationsI nake some simple statement on the loan schedule, such as that the excess was "voluntarily pledged" or "not requested or required." March 14, 1952. NOTE: I talked with Arthur Olson on the telephone today about the matter referred to above. He rwidily agreed to have appropriate notations placed on future schedules. In response to my request, he said he would also take it up with the Detroit Branch. R. F. Leonard '6-1-1-71-77-7UT., _EC D.L. Werner ,A.Mia.••••.••••••.••••••• WO 4 195? 10101.1... MEMORANDUM March 3, 1952 To: / Mr. Leonard From: M. In reviewing the loan schedules submitted by the Federal Reserve Banks recently, we noticed that the Atlanta Federal Reserve Bank was apparently not observing paragraph (e) of Section 3 of the Board's Regulation A. It appears thac, in most, if not all, of the cases in which the Atlanta Bank's loan schedules show Government securities collateral in excess of the amount of the note, the excess may arise because of the large denominations of the securities pledged, usually Treasury bills. Most of the Reserve Banks, in reporting "excess" collateral in the form of Government obligations, make some simple statement on the loan schedule, such as that the excess was "voluntarily pledged" or "not requested or required." (The New Orleans Branch uses the phrase "excess collateral voluntarily pledged.") March 14, 1952. NOTE: I talked with Lewis Clark on the telephone today about the matter referred to above. He readily agreed to have appropriate notations placed on future schedules. (11\ R. F. Leonard FOR: FILM D. L. Werncr • FORM F. R. 326 11 , IN FILES SECTION , ,,D JAN 2 5 1952 CROSS REFERENCE IDOX XIXIINID 1X IAIX1 DATE 1/18/52 KIND OF MATERIAL: Memo Lewis to Vest NAME OR SUBJECT: Re: Application of Bankerci Blanket Bond aid Loss Sharing Agreement to a loss of pledged securities held by custodian bank REMARKS: Filed 322.5 CHECKED BY DATE MD 1/25/52 ; 7D IN FILES SECTION ' ro;r. Vest c:roa; NOV8 1951 c4( hovember 7, 1951 awls .0 4 , 6:' 41 This is in firther refertnce t the litAlity of * i'ederal eserv* t.o pledgini; member iitcause Tresery's ircultir 92 state* th4,. collstral scourtty must 4 deposited with a aistodian *designstodu by a i'ederal Ntistrve Fan, thrm Ajit It5 some inference that the Iiesfs:rve Jank and not the mexiAr actually desianc,es the cuts-. todisn the pledged securities. !ovlavers the actual facts of the eitqation vocold ZOON to mote thie Infrence. As wto ;now, the pledged securities are alrced'; ritAltint in the hands of the correspondent Lienk of the member 'ziani: before a revet. is csJe for a lean from a YTserve jmnk. In most e4seu the , , Aest rve 'Jenit approves the correzpondent bank cting as ccs?,Odian if it meets the tow q aallf4cetlons placed , Ipon it. it would cie difficult to sik, ander thcsectra , stAncem that the iirdtril eservo totually 1.esit,ntAre the custodian. The ,iuestion ie dbvio-isly not an open and shut one, as utist e inferred tr the eemoranditst, and the provision in section 11 of the Treastitry's (Amulet 92 could be 4sed to disadvantai,A in cote of an actunl controversy. iiattemb 1 C Pnr 1 REVD IN FILES SECTION i\j11 1 1 8 . 1951 • Le)..„,:::) ...,), t 1 2., s.,,,, ' November est r. Levis deral _eserve 'ankts liatility as holder ol custodian receipts. This is in reference to a euestion you asked ne aevergl days ago regardine the nature and extent ce the liatility of a Tederal Reserve 3ank to a pledging country member bank. rith reepect to lose or demo te te._ pledged collateral zecurity in the custody of either correspondent tanks or another Federal heserve a.rtk (invarlaLly the New. York fAtserve ennk.). Under normal circumstances the pledgee property is in the possession of the pledeee and the prevailing general rule is that the pledeee mest exercise oreinary or reasonable care in its prenorvaeion. This care hue eeen described as thee which e reason— e'ele man under like circumstances vould recognize as necessary to prevent his conduct from creating en enreasonaele risk of harm to the pledged property (Festutement of Law of Security, section 17). It is likewise the same degree 01 care that is exercised by the pledgee in sal:eguarding his awn propeety. However, the eeercise of ordinary care is sefficient; the pledgee is not an insurer of the property pledged, and he need not exercise every possible precaution to prevent less. He Is not lisle for devotees yhich arise without legal fault on his part, as ellre 112 mnkes'un honest error in jedgment or vire the loss is caused by an overpopering force, such as an Jct of ar. Lee 72 52-53) This, it is extremely doettful thee a plcdeee eteali be held liable for damaee or loss to the pledged property =wed by action of an enemy country durinc wartime. It is understood, of course, thet these rules may be varied by an cypress eereement betreen the parties. !_ikewise, those rules are modified *here the pledgee has not en given exclusive control of the pledged property, as for an example, where securities are used at the pledged property and the pledgor has the right of eubstitution, exchange or redemption. It is then the veual duty of the pledgor to ere forth* pledged property and he cannot hold the pledgee responsible for any lose each could have been prevented by due care on his part. dedgq4 4eurity In t:eetoy of ;:orres_pondent ank Under this arrangement, the securities owned ey the bor— rowing member bank, which nre held in sa:ekeepinc by one of its C cy ....... I T.LES FOR r. ;, ' I... 1..I. (Jolloch 1 I I Mr. 'Jest -2- correspondent banks, are not ibrwarded to the Reserve rank makin6 the loan, Uut instead a custodian receipt is issued by the correspondent bank upon request of the Uorrowing bank which states that: the correspondent bank holds specific securities in custody for the Eeserve ank and subject to its exclusive control. This arrsngement is made possible by section 11 of 1reasury Circular 92, which states thaf, all securities accepted Eis collateral securities may be deposited with a "custodian or custodians ithin the United states designated -,ank, and under such terms and conditions as by such Federal Heserve : it may prescribe". It is clear that the Reserve ;:ank as pledgee does not have actual physical possession of the pledged property. Section 17 of the Restatement of the Law of Fecurities states the following rule with r gard te the duty of a pledgee where the pledged property is in the custody of a third party: The pledgee owes to the pledgor the arty of reasonable care of the pledged chattel ercept where the chattel is in the possession of a third person designated by the pledgor or is in the possession of the pledgor himself." (jnderlining supplied) As custodian receipts are employed for the benefit and convenience of the borrowing member ban}: and its pledged securities are in the custody of a correspondent bank selected by the member bank (within certain prescri7)ed limitations), it wo.Ald appear that the third party in possession of the pledged chattel under this arirang,ement was designated by the member uank within the meaning of Section 17, which would relieve the Reserve aank of any duty regarding the safekeeping of the pledged property. It is doubtful that the few limitation prescribed by the Reserve banks with regard to the qualificationlithe correspondent bank would be held to affect the Jank in designating the frerdom of choice of the pledging member , third party custodian. Pledged rlocurity in custody of Federal Reserve Bank Under this arrangement, securities owned by a borrowing member bank and in the custody of one of its correspondent banks (usually a New 'fork bank) are delivered to the Federal Eeserve jank of New York which holds them in safekeeping for the account of the ieserve Tank which is making the loan. Although this arrangement is for the convenience of the pledgor, it would be difficult to contend that the New York 1-ieserve bank was designated by the pledgor to act as custodian of the securities. A more reasonable Approach would C [:_?) seem to be that the Arrt York Reserve sank, being a memloter of the same system, vas acting as an PLent of the Reserve ,fink making the loan; therefore, the i‘eserve 'ank 'could be directly responsible for the ;tots of its agent despitde the fact that it does not have possession of the pledged property. Under this reasoning, the heserve :sank would undertake the general dlities of a pledgee for the safekeeping of the pledged securities as stated a. :)ove in ar:sence of any expressed agreement to the contrary. It should be mentioned that expressed agreements between the parties limiting th -liabillty of the pledgee to less than that of ordinary or reasonable care have been naturally very narrowly construed by the courts. 1 C E.)) 4 Mr. Leonard IL. E. Daniel - The Continental l‘itional BtFnk end Trust Company, Salt Lake City, Utah, borrowed $l9,830,000 from the Federal Leselve hank ofSan Fruncisco during the calendar year 1949. For the year ended April 30, this bank's borrowings totaled $11,930,000. The last date it borrowed (baL,ed on daily schedules received to date from the Salt Lake City Branch) was March 22, 19% when it borrowed $1,3:-0,000 on its one-day collateral note secured by Government obligations. All the borrowings have been secured by Governments and most or all of the borrowings werc for one day. L, -.. -----.....-7 .. , REVD Ii4 Fr.'2 --,, . I July 24, 194. Mr. G. R. Murff, Federal Reserve Examiner, Board of Governors of the Fedeml Reserve System, Washingtoh 25, D. C. Dear Mr. Murff: Enclosed is a copy of a memorandum dated Zuly 6 from Mr. Carpenter regarding advice ns to the mannrr in which the various Federal Reserve i4.111iCS adviso their member banks of ths procedure with respect to th acceptance y the Reserve flant:s of custody receipts by member banks os collaterl for loans to othor member ben). '.111 you please be guided accordingly. Very truly yolirs, E. F. Leonard, Director, Division of Examinctions. Enclosur. RFL:hik ^ 1 JUL 22 1948 ••••••••• _..,.—.. ri VD Li FILPS SECTiON arD OF GOVERNORS JUL 22 1948 OF THE FEDERAL RESERVE SYSTEM I Office Correspondence To From Mr Subject: Tprinrd Mr Date July 6, 1948 Cnr7lenter Attached is a copy of a letter sent to the Presidents of the Federal Reserve Banks on July 2 transmitting a statement with respect to the acceptance by the Federal Reserve Banks of custody receipts for Government securities as collateral for loans to member banks. It was the informal understanding when the letter was approved that at the time of the examination of the respective Federal Reserve Banks the Board's examiners would check into the method followed by the Federal Reserve Bank in advising its member banks of the availability of the service and that a report on the matter would be made to the Board either in the report of examination or otherwise. Would you see that the necessary instructions are is- sued to Mr. Murff so that this informal understanding can be carried into effect? Attachment 1 MClir FILES SECTION UL 7 1948 BOARD ,EfF G6VERNORS OF THE FEDERAL RESERVE SYSTEM WASHINGTON 25. D. C. D _f?* r •`", S-1026 ADDRESS OFFICIAL CORRESPONDENCE TO THE BOARD (4 '**144, Not July 2, 1948. Dear Sir: At the joint meeting of the Board and the Presidents of the Federal Reserve Banks on May 21, 1948 there was a further diecussion of the statement set forth in tne Board's letter of April 5, 1948, with respect to the acceptence by the Federal heserve lenks of custody receipts for Government securities as collateral for loans to member banks. Durine, the discussion there was agreement that the practice of accepting such receipts would enable the Federal Reserve Banks to be of greater service to their member banks which should be encouraged, but that the statement in the Bcx,rd's letter of April 5 should provide thet the Federal Reserve Banks would accept only custody receipts issued by member brnks satisfactory to the accepting Federel Reserve Blnk. There was also agreement that the procedure should provide th-t each Federal Reserve Bonk would adopt its own method of advising member banks in its district which would insure the member banks' knowing that the service was available. In the light of these agreements the statement contained in the Board's letter of April 5, 1948 1has been revised to read as follows: _ "The Federal Reserve 3anks in 1947, in recognition of the existing practice of member beaks of having securities held where they can be sold quickly, particularly in the New York market, without incurring substantial shipping charges, adoptud a procedure under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securitiees, in limited amounts, bolo-ling to a member bank in another Feder-1 Reserve district in order that such socuriti3s might be used as collateral for a loan to such member bank by the Federal Reserve Bank of its district. This procedure requires the physical deposit of the securities with the Federal Reserve -2- S-1026 91ank of New York Lnd their redelivery to the New York corre: spondent bank when the need for borrol.rinf ; by the member benk has passed. "With a view to further improvement in the services of the Reserve Baake to their member Larks and in order that their credit facilities may operate rs conveniently and expeditiously as possible, any Federal Reserve Bank will also accept as collateral security for a loan to a member bank custody receipts covering Government securities, when the receipts axe in a form satisfactory to the Reserve Benk and are issued by a member bank which is satisfactory to the Federal Reserve Bank and which in the usual course of business performs correspondent bank services, including the holding in custody of Government securities, for the borroering member bank. Each Federal Reserve flank will dopt its own method of advising member banks in its district which will insure the banks' knowing that tee service is Very trup S. R. (erpe er, Seeretery. TO THE PRESIDEgTS OF ALL FEDERAL RESERVE BANK9 JUL 2 1948 Dear Sir: At the joint meeting of the Board and the Presidents of the Federal Reserve Banks on May 21, 191B there was a further discussion of the statement set forth in the Board's letter of April 5, 190, with respect to the acceptance by the Federal Reserve Banks of custody receipts for Government securities as collateral for loans to member banks. During the discussion there was agreement that the practice of accepting such receipts would enable the Federal Reserve Banks to be of greater service to their member banks which should be encouraged, but that the statement in the Board's letter of April 5 should provide that the Federal Reserve Banks would accept only custody receipts issued by member banks satisfactory to the aooepting Federal Reserve Bank. There was also agreement that the procedure should provide that each Federal Reserve Bank would adopt its own method of advising member banks in its district which would insure the member banks' knowing that the service was available. In the light of these agreements the statement contained in the Board's letter of April 5, 1948 has been revised to read as follows: "The Federal Reserve Banks in 1947, in recognition of the existing practice of member banks of having securities held whore they can be sold quickly, particularly in the NOW York market, without incurring substantial shipping charges, adopted a procedure under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securities, in limited amounts, belonging to a member bank in anothor Federal Reserve district in order that such securities might be used as collateral for a loan to such member bank by the Federal Reserve Bank of its district. This procedure requires the physical deposit of the securities with the Federal Reserve Bank of New York and their redelivery to the New York correspondent bank when the need for borrowing by the member bank has passed. ^ - 2- "With a view to further improvement in t-Ae services of the Reserve Banks to their member banks and in order that their credit facilities may operate as conveniently and expeditiously as possible, any Federal Pecerve Dank will also accept as collateral security for a loan to a member bank custody receipts covering Government securities, when the receipts are in a form satisfactory to the Reserve Dank and are issued by a member bank which is satisfactory to the Federal Reserve Dank and which in the usual course of business performs correspondent bank services, including the holding in custody of Government securities, for the borrowing member bank. Each Federal Reserve Bank will adopt its own method of advising member banks in its district which will insure the banks' knowing that the service is avail— able." Very truly yours, (SIGNED) G. R. CARPENTER S. R. Carpenter, Secretary. For Approval ip First to 4 ste-cts°1--- Mr. McCabe Mr. Eccles WY"' -t Mr. Szymczak et Mr. Draper Mr. Evans Mr. Vardaman ' Mr. Clayton If you approve, please initial and return to Mr. Brennan TO THE PRESIDENTS OF ALL FEDERAL RESERVE BAPES. NiiTt7r7P1.(1141k:k JUL 2 1948 F0:I P.:LES I Gordon Grin:iv-rood PU ) FILES SECTIOg IN JUL 1 4 1948 Ilw Dear Sir: La its letter of April 5, 19480 the Board set forth a proposed 'eolicy statement in connection with the acceptance by Feder al Reserve Banks, as collateral security for arioan to a member bank, of custody receipts of responsible city cpi-respoedent banks cover ing Government securities. Replies to the ard's letter indicated that most of the Reserve Banks were oppose to the issuance of a statement in the form suggested. // The matter was again dilpcussed at the Presidents' Confer( ence of litlay 18, 1948, and at therfjoint meeting of the Board and the ?residents on May 21. At the )tter meeting, it was indicated that there would be no objection the part of the Board to changing the proposed procedure to provid6 that the Federal Reser ve Banks would accept custody receipts isl Kied by a member bank satis i factory to the Federal Reserve Bank, an 'there 4723 substantial areem ent with the statement contained in e Board's letter of November 25, 1947, that the Reserve Banks may operly accept custody receipts of responsible city correspondent b • for reasonable periods where actual delivery of securities is no convenient for the borrowing bank. At this meeting also it appear that all of the Presidents agreed that it would be desirable to ourage the practice in question and "that each Federal Reserve sank will adopt its awn method of advising member banks in its d3trict which will insure the banks knowing that the service is av It will be appreciated if you will inform the Board sometime after the first of the year of the procedure followed in advising the member banks in your District of the availability of the service. Very truly yours, S. R. Carpenter, Secretary, TO THE PRE . T r ALL AL PILLS Gordon Grim - 7ood I . r !tte,(31.) IN FlIAE AIN 2 8 1948 Yr. Charles 0. Young, Jr.. Secretary, Conference of Presidents, Federal Reserve ilink of St. Louis, 'It. Louis 2, Missouri. Pear Charlie, I have your letter of June 18, 1943 with reference to aotion by the %aid on expenses of officers and employees of Federal Reserve Ranks attending banking sahools. Fly this time you will have received the letter whioh the Board has addressed to the Banks on this matter. We have another letter in the works which will go out in due course and which will state the understanding reached at the joint meeting with respect to custody receipts as collateral for loans to member banks. Also the Board is considering the problem of reduoing the amount of Federal le serve Piank earnings being paid to the Treasury and something will go out on that shortly. Very truly yours, H. t;iktiri.N1T-P. S. R. Carpenter, Secretary. C 'MON 11113ARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Office Correspondence Dee June 11 , 1948 4 To The Files Subject: Telephone conversation with From Donald S. Thompson Mr. Jacobstein, Legislative Research Bureau, Library of '®Ec4 FILES SECTION JUN 2? 1946 A Congressman wanted to know what would be of an amendment placing a ceiling on the amount of Govern 'D IN FILEti ST obligations that could be pledged against notes. I point d ont that if we reached the ceiling and used up all of the 7,01 JUN 28 1948 available it would necessitate the sale by the Federal Re erve System of Government securities in order (a) to reduce depasit at the Federal Reserve Banks and thus free gold for pledging against notes, or (b) to force member banks to borrow so that eligible paper could be pledged as collateral for Federal Reserve notes. Inasmuch as banks traditionally dislike to borrow at the Federal Reserve, an increase in demand for currency would result in considerable pressure for liquidation of Government ;. securities with resulting adverse effects on the Government market. Even if the proposed ceiling left us with plenty of room, the mere fact of its existence might cause many holders to dispose of Government securities in the expectation of a break in price. The objective of this proposal is really to put a on the extent to which the Federal Reserve System can limit support the Government market. That is an issue tha', should be faced squarely by the Congress and action taken on it as a matter of policy rather than through the back door by putting a straightjacket on Federal Reserve operating procedure. The present methods and provisions for pledging assets against Federal Reserve notes have been developing over a period of time on the basis of practical operating experience. They are separate from the provisions of law having to do with Federal Reserve credit policy. The amount of money in circulation is determined not by the Federal Reserve System but by the public. The Federal Reserve notes are not the highpowered money of our system. If limitations are to be sought on the power of the Federal Reserve System to issue money, those limitations should be placed not on the notes but on the deposits, -which are the highpowered currency which can be pyramided into expanded deposits and credit in our economic system. OARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Office Correspondence To Mr. Smead From ->7-4/ Date DEC 28 June / 19 48 1)\(41 148 9 Mr. Sherman Subject: The following excerpt from the minutes of the meeting of the Board with the Presidents of the Federal Reserve Banks on May 21, 1948, is quoted for your information: ".1. Custody receipts for collateral securiu loans to member banks. "Presidents' statement: The presidents reviewed, and discussed with Governors Clayton and Vardaman and Mr. Smead, the subject heretofore considered of general acceptance by Reserve Banks of custody receipts for collateral securing loans to member banks. This matter was the subject of the Board's letter (S-1000) of November 25, 1947, and its letter of April 5, 1948. The presidents have already replied individually to the Board informing it of their views on this, subject as requested in the Board's letter of April 5. The presidents are in accord with the Board's letter S-1000, in which the Board stated that the Reserve Banks might properly accept custody receipts of responsible city correspondent banks, as well as those of the Federal Reserve Bank of New York, for reasonable periods where actual delivery of securities is not convenient for the borrowing bank. Many of the Reserve Banks have been doing this for some time and the presidents concur in the Board's view that this practice may enable the Reserve Banks to be of greater service to their member banks, a matter which should be encouraged. Recognizing that the acceptance of custody receipts may in some instances involve risks and that the primary responsibility for making loans on the basis of such receipts lies with the respective Reserve Banks, it is the consensus of the presidents that it would be unfortunate if the practice were advertised and promoted by a published statement. Therefore they would prefer to forego the publication of a statement such as that set forth in the Board's letter of April 5. It is the feeling of the Conference thut the right of a Reserve Bank to reject custody receipts in any particular case should not be impaired by any generalized statement seemingly indicating a willingness of the Reserve Banks to accept such receipts from any correspondent bank. "Board's response; The Board understands from Mr. " /, Clayton that he and Mr. Vardaman stated when they met with Ce /5,ov (/'' t • Mr. Smead 6/2/48 "the Presidents that they thought there would be no objection on the part of the Board to changing the proposed procedure to provide that the Federal Reserve Banks would accept custody receipts issued by a member bank satisfactory to the Federal Reserve Bank. The Board has noted that the Presidents are in accord with the Board's letter of November 25, 1947, in which it was stated that the Reserve Banks may properly accept custody receipts of responsible city correspondent banks for reasonable periods where actual delivery of securities is not convenient for the borrowing bank. It appears therefore that there is substantial agreement on the matter except that the Board believes that the procedure should provide that each Federal Reserve Bank will adopt a method of advising all member banks in its district which will insure the banks knowing that the service is available. "Mr. Davis stated that the Presidents were strongly of the opinion that, as set forth in their statement quoted above, it would be unfortunate if the practice of accepting trust readpts were advertised and promoted by a published statement for the reason that a difficult question of bank relations might arise in any case in which a Federal Reserve Bank found it necessary to decline to accept a receipt from a particular bank. He also said that the only question of difference seemed to be, as stated by the Board, the extent to which the service should be advertised. "There was a discussion of Mr. Szymczak's inquiry as to the value of the service if it was not known to member banks, and Mr. Peyton inquired whether it would meet the views of the Board if advice of the availability of the service were given by the bank relations men in their visits to member banks once or twice a year. Mr. Szymczak stated that it was understood that the Federal Reserve Bank of Philadelphia proposed to advise member banks of the service at the time of regional conferences throughout the district. Mr. Davis said that the adoption of such methods of advice would be in line with the discussions of the Presidents. "Mr. Eccles stated that it was the consensus of the members of the Board that they wanted to be sure that each Federal Reserve Bank would see to it that all members in the various districts would know that the service was available to the extent that the custody receipt was issued by a member bank acceptable to the Federal Reserve Bank. "Mr. to, or should, of the service the service is Sproul questioned whether the Board had the authority tell the Federal Reserve Banks how the availability should be made known and suggested the manner in which brought to the attention of the member banks be left • Mr. Smead -3 - "to the Federal Reserve Banks for decision. Mr. Eccles responded that the Board was not trying to tell the Federal Reserve Banks how to advise their member banks but rather that the member banks should be informed. "Mr. McCabe suggested that the last sentence of the Board's statement as set forth above be revised to read as follows: 'It appears therefore that there is substantial agreement on the matter except that the Board believes the procedure should provide that each Federal Reserve Bank will adopt its own method of advising member banks in its district which will insure the banks knowing that the service is available.' "Mr. Davis stated that it was not only a question of a particular bank being in a satisfactory condition and satisfactorily managed, but also whether the practice of accepting custody receipts from correspondent banks no matter where they are located might result in distorting the normal pattern of correspondent bank relationships that has developed out of need for service. "Mr. Clayton suggested that there was still a question whether under the proposed arrangement some Federal Reserve Banks would accept custody receipts from any of their member banks. "Mr. Sproul responded that all of the Presidents had agreed that it would be desirable to encourage the practice and that it should be assumed that all Federal Reserve Banks would follow that policy. "After some further discussion, Mr. McCabe suggested that, as a means of deciding the matter, the Presidents and the Board of Governors agree with the last sentence of the Board's statement amended in the manner he had proposed. This suggestion was agreed to unanimously." cc: Mr. Vest • OfREC'D IN FILES SECTION SEP 11 1953 , lL Custody receipts for collateral securing loans to member banks Mr. Leach referred to the discussions at the meetin7 of the Conference and at the joint meeting of the Board and the presidents, in February 1948 (mins., pr). 7, 26-30), relating to the acceptance of custody receipts as collateral for loans to member banks, and to theBoard's letter of April 5, 1948, setting forth a pr000sed policy statement of the Board and requesting comments by the Reserve Banks. The Chairman of the Conference, having been informed of the desire of Messrs. Clayton and Vardaman, members of the Board of Governors, to discuss this subject with the presidents, Messrs. Clayton and Vardaman, and also Mr. Smead, Director of the Board's Division of Bank Operations, attended the meeting at the invitation of the presidents. The subject was discussed in detail. The presidents indicated that they are in accord with the Board's letter(S-1000) of November 25, 1947 (Fed.Res.L.L.Serv. #5130), in which the Board stated that the Reserve Banks might properly accept custody receipts of responsible city correspondent banks, as well as those of the Federal Reserve Bank of New York, for reasonable periods where actual delivery of securities is not convenient for the borrowing bank. From the discussion it appeared that many of the Reserve Banks have been following this practice for some time, and that the presidents concur in the Board's view that such practice may enable the Reserve Banks to be of greater service to their member banks, an objective they agreed should be encouraged. It was the consensus of the presidents that of the practice, by advertisement and promotion published statement, would be unfortunate and undes since the acceptance irable, of custody receipts may in some instances involve risks since the primary respo and nsibility for making loans and determining the of collateral lies with acceptability the respective Reserve Banks. The presidents indic that they would prefer ated not to publicize a state ment such as that set forth Board's letter of April 5, in the since the right of a Reser ve Bank to reject custody receipts in any particular case might be prejudiced or statement apparently indic impaired by a generalized ating a willingness or oblig ation to accept such receipts from any correspond ent bank. At the close of the discussion, Messrs. Clayton that the second paragraph and Vardaman suggested of the proposed policy statement, set forth in the Board's letter of April 5, might be modified so as to bank issuing the custody indicate that the member receipts should be satisfacto ry to the Reserve Bank. This might be done, they said, by inserting the words Bank" immediately following "satisfactory to the Reserve the words "issued by a member bank". It was under that the subject would be stood discussed further at the joint the presidents to be held meeting of the Board and on May 21, 1948. At this point Messrs. Clayton, Vardaman and Smead left the meeting. 1 • lifREC'D IN FILES SECTION SEP 15 1953 1. Custody receipts for collateral securing loans to member banks, Presidents' statement: The presidents reviewed, and discussed with Governors Clayton and Vardaman and Mr. Smead, the subject heretofore considered of general acceptance by Reserve Banks of custody receipts for collateral securing loans to member banks. This matter was the subject of the 'oard's letter (5-1000) of November 25, 1947, and its\letter of April 5, 1948. The 0 -sidents have already replied e individually to the Board informing it of their views on this subject as requested in the Board's letter of April 5. The presidents are in accord witn the Board's letter S-1000, in which the Board stated that the Reserve Banks might properly accept custody receipts of responsible city correspondent banks, as well as those of the Federal Reserve Bank of New York, for reasonable periods where actual delivery of securities is not convenient for the borrowing bank. Many of the Reserve Banks have been doing this for some time and the presidents concur in the Board's view that this practice may enable the Reserve Banks to be of greater service to their member banks, a matter which should be encouraged. Recognizing that the acceptance of custody receipts may in some instances involve risks and that the primary responsibility for making loans on the basis of such receipts lies with the resoective Reserve Banks, it is the consensus of the presidents that it would be unfortunate if the practice were advertised and promoted by a published statement. Therefore they would prefer to forego the publication of a statement such as that set forth in the Board's letter of April 5. It is the feeling of the Conference that the right of a Reserve Bank to reject custody receipts in any particular case should not be impaired by any generalized statement seemingly indicating a willingness of the Reserve Banks to accept such receipts from any correspondent bank. Board's response: The Board understands from Mr. Clayton that he and Mr. Vardaman stated when they metmith the presidents that they thought there would be no objection on the part of the Board to changing the proposed procedure to provide that the Federal Reserve Banks would accept custody receipts issued by a member bank satisfactory to the Federal Reserve Bank. The Board has noted that the presidents are in accord with the Board's letter of November 25, 1947, in which it was stated that the Reserve Banks may properly accept custody receipts of responsible city correspondent banks for 22 reasonable periods where actual delivery of securities is not con— venient for the borrowing bank. It appears therefore that there is substantial agreement on the matter except that the Board believes that the procedure should provide that each Federal Reserve Bank will adopt a method of advising all member banks in its district which will insure the banks knowing that the service is available. Mr. Davis stated that the presidents were strongly of the opinion that, as set forth in their statement quoted above, it would be unfortunate if the practice of accepting trust receipts were advertised and promoted by a published statement for the reason that a difficult Question of bank relations might arise in any case in which a Federal Reserve Bank found it necessary to decline to accept a receipt from a particular bank. He also said that the only question of difference seemed to be, as stated by the Board, the extent to which the service should be advertised. There was a discussion of Er. Szymczakts inquiry as to the value of the service if it was not known to member banks, and nr. Peyton inquired whether it would meet the views of the Board if advice of the availability of the service were given by the bank relations men in their visits to member banks once or twice a year. Mr. Szymczak stated that it was understood that the Federal Reserve Bank of Philadelphia proposed to advise member banks of the service at the time of regional conferences throughout the district. Mr. Davis said that the adoption of such methods of advice would be in lino with the discussions of the presidents. Mr. Eccles stated that it was the consensus of the members of the Board that they wanted to be sure that each Federal Reserve Bank would see to it that all members in the various districts would know that the service was available to the extent that the custody receipt was issued by a member bank acceptable to the Federal Reserve Bank, Mr. Sproul questioned whether the Board had the authority to, or should, tell the Federal Reserve Banks how the availability of the service should be made known and suggested the manner in which the service is brought to the attention of the member banks be left to the Federal Reserve Banks for decision. Mr. Eccles responded that the Board was not trying to tel] the Federal Reserve Banks how to advise their member banks but rather that the member banks should be informed. Mr. McCabe suggested that the last sentence of the Boardts statement as set forth above be revised to read as follows: "It appears therefore that there is substantial agree— ment on the matter except that the Board believes the procedure should provide that each Federal Reserve Bank will adopt its own method of advising member banks in its district which will insure the banks knowing that the service is available." Mr. Davis stated that it was not only a question of a particular bank ' being in a satisfactory condition and satisfactorily managed, but also whether the practice of accepting custody receipts from correspondent banks no matter where they are located might result in distorting the normal pattern of correspo n— dent bank relationships that has developed out of need for service. V Mr. Clayton suggested that there was still a question whether under the proposed arrangement some Federal Reserve Banks•would accept custody receipts from any of their member banks. Mr. Sproul responded that all of the presidents had agreed that it would be desirable to encourage the practice and that it should be assumed that all Federal Reserve Banks would follow that policy. After some further discussion, Mr. McCabe suggested that, as a means of deciding the matter, the presidents and the Board of Governors agree with the last sentence of the Board's statement amended in the manner he had proposed . This suggestion was agreed to unanimously. / 7 I' • I ,ar j ip.o t N1i PT. 7ECTI2N LF I MAY OARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Office Correspondence Date -nay To General Files Subject: Transfer of debt and collateral; From Mr. Sha collateral held by third party With reference to loans by Federal Reserve Banks to member banks, the collateral is sometimes securities of the member bank in the possession of a correspondent-aepository bank. (See sec. 13, para. 8, Federal Reserve Act) As to the pledge of such securities by the member bank as collateral for its loan from the Reserve Bank, the following may be noted: Where property is in the possession of a third person a pledge may be created by the assent of the pledgor and notification by either the pledgor or the pledgee, to the third person, that the property has been pledged to the pledgee. Restatement of Security, sec. 8. Should the Federal Reserve Bank transfer and assign the member bank's loan note to the local Federal Reserve Agent as a basis for Federal Reserve notes (see sec. 16, para. 2, Federal Reserve Act), a question arises as to whether the pledge of collateral security held by a third party -the correspondent-depository bank--follows the debt. In this regard, the following is pertinent: The assignment of a debt ordinarily carries with it all liens and every remedy or security that is incidental to the subject matter of the assignment and that could have been used or made available by the assignor as a means of indemnity or payment even though they are not specifically named in the assignment and even though the assignee at the time of the assignment was ignorant of their existence. This general principle applies to the assignment of a bill or note, and the holder's right attaches to the security so long as it can be traced. Any such assignment or negotiation carries the prior-1 4- 1es of the original holder of . the note with respect to the security. 8 Am. Jur. (bills and notes) sec. 339. In the normal situation of a debt secured by a pledge, the pledge follows the debt. By an assignment, the assignor's right to performance is extinguished and the assignee acquires the right to performance; and the assignee's rights in respect to the pledge are not dependent upon his knowledge of the existence of the pledge at the time of the assignment. Thus, if a claim secured by a pledge is assigned to one who assumes it is unsecured, the assignee nevertheless is equitably entitled to the assignor's pledge interest. Restatement of Security, sec. 29, comment b. The pledge and the claim it secures are inseparable. Thus, if the pledgee and the assignee agree that the claim is to be assigned without security, the pledge is terminated, and the pledgor is entitled to the return of the pledged property. Ibid p. 95. General Files -2- The foregoing statements of law are demonstrated in Schram v. Sage et al., 46 F. Supp. 381 (D.C., Mich., 1942), rehearing den. 47 F. Supp. 94 (1942). In this case the plaintiff, a receiver for the First National Bank, Detroit, sued for interpleader of conflicting claims of defendants Sage and Brandt. Briefly, as security for his loan note for a,000, Brandt had pledged to the Bank two lots of corporate shares. Brandt was also indebted on certain notes to Huebner & Co.; and by an agreement of March 2, 1931, between all the parties interested, Brandt assigned all his right, title and interest in the aforementioned shares to Huebner & Co. as collateral, preserving, however to the Bank, all its existent rights to the shares. On June 22, 3932, the claim of Huebner & Co. against Brandt was reduced to judgment which, however, became barred by the Statute of Limitations by July 31, 1939, when Sage became assignee of the Huebner & Co. claim against Brandt. Previous to this assignment - that is, on August 25, 1935 -- the Bank sold one of the lots of shares pledged with it in foreclosure and extinguishment of Brandt's debt, leaving a $160 overplus and the second lot of pledged shares. In rendering judgment directing plaintiff to deliver to Sage the ,160 overplus and the second lot of shares, the Court, inter alia, said: "As stated in Section 8, Restatement of the Law of Security: 'Where a chattel is in the possession of a third person a pledge may be created by assent of the pledgor and notification by either pledgor or pledgee to the third person that the chattel has been pledged to the pledgee.'" The Court said further that the agreement of March 2, 1931 "created a pledge junior to the Bank's pledge, and upon termlnation of the superior pledge the junior pledge was entitled to rossession of the remainder of the pledged property." Cntinuing, the Court said: "Assignment of a debt secured by :ledged property in possession of a third person operates as a transfer to the then-creditor of all the pledgee's rights, so that upon assignment to defendant Sage of the judgment, he succeeded to all rights of Huebner & Company in said pledge agreement securing such debt. Section 29, Restatement of the Law of Security." Finally, the Court said that "although action on the debt is barred by limitation, as here", still, "A creditor, as Sage, may hold and realize on collateralpledged to secure" the debt. Thus, Brandt could recover possession of the pledge only by paying his debt held by Sage. In Lesnich v. Public Industrials Corl:oration, et al, 144 F. (2d) 968 (C.C.A., 2nd 1944) an action against the Corporation upon a note secured by shares of another company, the Court held as properly dismissed by the lower court the Corporation's counter-claim charginr that three persons named , ..4 • General Files -3- as third•girty defendants conspired with the original plaintiff to bring about an illegal sale of the collateral, where the record was barren of proof that such sale was in fact illegal. In this regard, the Court also said "Rather, it is clear that the sale or assignment of a secured indebtedness carries with it the assignor's rights in the security, which here included full powers of sale", citing Schram v. Sage, supra, and Restatement of Security (1941), sec. 29. Clearly, the foregoing does not reflect a comprehensive study of all aspects of the law in this regard. But, on the basis of the above, a pledge of collateral security held by a third party would follow the debt; and, therefore, the question presented in the third paragraph hereof would seem entitled to an affirmative answer. MAY 1 P. 1948 II MAIL Nr. Chester C. Davis, Chairman, Conference of ?residents, Feneml Reserve Bank of St. Lcn;15, St. Luis Missouri. XI.. Davis; . The Board has receivd replies fror the Fed— eral fteserve Bank to its letter dated Aprik_54„ 194B, tisk— ing for their views oa a propoed statement of policy with reil?ect to the acceptcnce of custody receipts as collateral for advaaces to member balks. It is noted that thia topic Is on the agenda for the forthcov.ing Presidents' Conference and it has occurred to the Board th;t: it would tic. helpful if, before the Presidents formulate their .conclusions on the tter, oportunity could he given '-essrs. VardaNan and. Clayton to discuss it ut one of the Conference sessions. If this can be arrarved and you Mill let 7te k.nou when the natter is to be taken up at the 2reriidentst Conference, I viii advise eff,srs. Vardaan and Clayton so that they can be available for the discussion. Very truly vurs, (SIGNED) S. R. CARPE7( , 8. R. Carpenter, Secretary. p_2)y 1 OAR!) OF GOVERNORS .7.-''' OF THE FEDERAL RESERVE SYSTEM Office Correspondence To Board of Governors From ir. Van Fossen I irl -wiRjils :.-4,EcrioN i / 2 /W i. 8 1948 . ") #7) LI Mae May 5, 1948. Subject: Acceptance of custody receipts as collateral to advances to member banks. On April 5, 1948, the Board wrote the Presidents of the Federal Reserve Banks asking for their views on the following proposed statement of policy, and what steps should be taken to bring the proposed service to the attention of member banks: "The Federal Reserve Banks in 1947, in recognition of the existing practice of member banks of having securi— ties held where they can be sold quickly, particularly in the New York market, without incurring substantial shipping charges, adopted a procedure under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securities, in limited amounts, belonging to a member bank in another Federal Reserve district in order that such securities might be used as collateral for a loan to such member bank by the Federal Reserve Bank of its district. This procedure requires the physical deposit of the securi— ties with the Federal Reserve Bank of New York and their redelivery to the New York correspondent bank when the need for borrowing by the member bank has passed. "With a view to further improvement in the services of the Reserve Banks to their member banks and in order that their credit facilities may operate as conveniently and expeditiously as possible, any Federal Reserve Bank will also accept as collateral security for a loan to a member bank custody receipts covering Government securities, in form satisfactory to the Reserve Bank, issued by a member bank which in the usual course of business performs corres— pondent bank services, including the holding in custody of Government securities, for the borrowing member bank." A review of the replies from the Reserve Banks to the Board's letter indicate that nine of the Reserve Banks appear to be opposed to the adoption of the statement of policy suggested by the Board. Their reasons may be summed up briefly as follows: The present arrangement with the Federal Reserve Bank of New York for holding in custody Government securi— ties belonging to member banks in other districts, when pledged to secure loans from Reserve Banks of other districts, is probably adequate for all practical purposes to meet the needs of member banks. of 1 Af36, GTift),N5 C,:00.011. 000. „-- Board of Governors - 2- The procedure to be followed with respect to the custody of the security for a loan should be left to the discretion of the officers and directors of the lending institution. The right of a Federal Reserve Bank to determine which bank's receipts will be accepted should not be impaired by any generalized statement to the effect that it will accept, unreservedly, safekeeping receipts from any correspondent bank. It is pointed out that the issuance of a statement implying the acceptability of custody receipts of any correspondent bank might result in considerable embarrassment in the event a Federal Reserve Bank refused to accept a particular bank's receipt and were compelled to state its reasons for such refusal. The adoption of such a policy would tend to depreciate the value of an important service which the Federal Reserve Banks render their member banks, and would play directly into the hands of a few who argue against State bank membership by saying that city correspondents can do for country banks everything that a Federal Reserve Bank can do. The suggested policy, if adopted, would supply a selling argument which some aggressive banks, specializing in country bank business, would use to the fullest extent in soliciting bank accounts and discouraging utilization of Federal Reserve Bank services. , ;(-4-3.\, For C'rculatiod e4-1 1\ alin ” 4 ?• A few of the replies suggest that the tbard explore the quesMr.1-Ctor.6,--' tion as to whether or not member bank collateral notes secured by custody receipts may be considered eligible as collateral for pledge . Mr McCabe UrZecurity against Federal Reserve notes. First Mr. Eccles Mr. Szytnczak Mr. Draper _-.._ Mr. Evan; Mr. Vardanian Mr. Cho told_ Mr. Thurston ...... Although most of the Reserve Banks are opposed to the issuance statement suggested by the Board, several of them have stated if any formal announcement is to be made of the availability of _procedure it would be desirable to state that a Federal Reserve Bank kè y, within its discretion and for brief periods, accept custody receipts c011ateral, rather than to say as the Board's statement does, "any FateTal Reserve Bank will Mr. Morrill The Federal Reserve Banks of Philadelphia, Atlanta, and Dallas Mr. Slicciiian_Z—are.-±he only banks which favor the adoption of the procedure suggested by the_Doard. 444L.H.,,,w444 Mr.. Mr. Mr. Carpenter/ Mr. Ple.F.e note, cited; and return to Mr. anal t Oi 7 194. • Mr. Clayton: Mr. Morrill spoke to me a couple of days ago about this matter aid said that when it reached our office on circulation he would like me to call it to your attention, since some consideration should be given to the question of rthat to do about it. A.I.C. 7 6.6--44 MAY 5-1948 • z7i — Way 5, 1048. Board of Governors 11r. Van Fossen Acceptance of custody receipts as collateral to advances to member banks. On April 5, 1948,' the Board 'rote the Presidents of the Federal leserve 13afikS asking for their views on the following proposed stateme nt of policy, and what steps should be taken to brina the proposed service to the at-Lention of member banks: "The Federal %serve Banks in 1947, in recognition of the existing practice of member banks of having securi— ties held where they can be sold quickly, particularly in the New York market, without incurring substantial shipping charges, adopted a procedure under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securities, in limited amounts, belonging to a member bank in another Federal Reserve district in order that such securities might be used as collateral for a loan to such member bank by the Federal Reserve Bank of its district. This procedure requires the physical deposit of the securi— ties with the Federal Reserve Bank of New York and their redelivery to the New York correspondent bank when the need for borrowing by the member bank has passed. "With a view to further improvement in the services of the Reserve Banks to their member banks and in order that their credit facilities may operate as conveniently and expeditiously as possible, any Federal 1ieserve Bank will also accept as collateral security for a loan to a member bank custody receipts covering Government securities, in form satisfactory to the Faserve 3ank, issued oy a member ..lank which in . the usual course of business performs corres— pondent Dank services, including the holding in custody of Government securities, for the borrowing member bank." A review of the replies from the Reserve 'Ranks to the Board's letter indicate that nine of the reserve Banks appear to be opposed to the adoption of the statement of policy sugpested by the Board. Their reasons may be sIrmed up briefly as follows: The present arrangement with the Federal Reserve Bank of New York for holding in custody Government securi— ties belonging to member banks in other districts, when pledged to secure loans from Reserve Banks of other districts, is probably adequate for all practical purposes to meet the needs of member banks. • ''OE Ir:.:17..c1.7.77- Board of Governors —2— The procedure to be followed with respect to the custody of the security for a loan should be left to the discretion of the officers and directors of the lending institution. The right of a Federal Reserve Bank to determine which bank's receipts will be accepted should not be impaired by any generalized statement to the effect that it will accept, unreservedly, safekeeping receipts from any correspondent bank. It is pointed out that the issuance of a statement implyinu- the acceptability of custody receipts of any correspondent oank might result in considera)le embarrassment in the event a Federal Reserve Bank refused to accept a par— ticular bank's receipt and were compelled to state its reasons for such refusal. The adoption of such a policy would tend to depreciate the value of an important service which the Federal Reserve Banks render their member banks, and would play directly into the hands of a few who argue against S'c.ate bank membership by saying that city correspondents can do for country banks everything that a Federal Reserve Bank can do. Ihe suggested policy, if adopted, would supply-a selling argument which some agrfressive banks, specializing in country bank business, mould use to the fullest ex— tent in soliciting bank accounts and discouraging utilization of Federal Reserve Bank services. A few of the replies suggest that the Board explore the ques— tion as to whether or not member bank collateral notes secured by custody receipts may be considered eligible as collateral for pled-:-e of security against Federal Reserve notes. Although most of the Reserve Banks are opposed to the issuance of the statement suggested by the Board, several of then have stated that if any formal announcement is to be made of the availability of the procedure it would be desiraJe to state that a Federal Reserve Bank may, within its discretion and for brief periods, accept custody receipts as collateral, rather than to say as the 3oardts statement does, "any Federal i'vaserve 'kink will The Federal aeserve Banks of Philadelphia, Atlanta, and lallas are the only banks 1.hich favor the adoption of the procedure sugpested by the Board. JJC:ct 1 1 C . TTEC'D ii\lii'll...v:'3 S(7,7177 80ARD OF GOVERNORS a/ OF THE FEDERAL RE1A • Ei. ( -rh148 • May 5, -.1:014 Mr. Smead: In connection with the attached memo, the most serious objection I can see tb the use of,/ such receipts as collateral - and it might be - -more fancied than real - is the possibility t'at 4•"4 1 for bankers get tough again you might , when times rue the day you ever began a practice that looks 0. K. at this time. For example, say that the "First" Bank of Podunk (which you know to be in unsound shape with unethical management), which might issue a receipt to its correspondent, which would in tarn offer the receipt to a Reserve Bank, how would the F. R. Bank explain to the correspondent that it could not honor the receipt, when it knew that the Reserve Bank had been accepting from its neighbor receipts issued by the "Second" Bank of Podunk? Moreover, bankers have resorted to some mighty strange practices when they have had their backs to the wall. They could very easily sell the pledged securities under a Repurchase Agreement, or even borrow on them, knowing that they would remain with them more or less permanently. However, these might be imaginary possibilities; but we have no reason to believe that all bankers are honest and will keep out of trouble. • 0471thr-7---74v-recmC__ FEDERAL RESERVE BANK OF KANSAS CITY KANSAS CITY 18, MISSOURI MAY b- — 1948 Vay 1, 1948 1L 7 Board of Governors of The Federal Reserve System Washington 25, D. C. Dear Sirs: This has reference to the Board's letter of April 5, 1948,\ concerning the proposal that the Federal Reserve Banks accept for reasonable periods custody receipts of responsible city correspondent banks as collateral for advances made to member banks where actual delivery of securities is not convenient for the borrowing bank. Supplementing President Leedy's letter of April 29, 1948, on this subject, we should like to cite two cases of mishandling involving receipts of commercial banks covering collateral pledged to secure war loan deposits, both of which further serve to raise doubts as to the feasibility of extending this service to include the holding of such receipts to secure member bank borrowings. The Stockgrowers State Bank of Worland, Wyoming, had deposited , ;60,000 in certificates of indebtedness with its correspondent at Cheyenne, 4 i Wyoming, to be held by the latter in safekeeping. Subsequently, our Omaha Branch accepted the safekeeping receipt of the Cheyenne bank covering the securities and held it as collateral to the ihar loan account of Worland. Upon maturity of the certificates the Cheyenne bank forwarded the securities to us at the Head Office for exchange for the new issue, which we effected without questioning as we were not aware that the securities had been pledged to the Omaha Branch. Approximately two weeks later the matter of the exchange of the pledged securities was discovered and while a new custody receipt covering the exchanged securities was promptly issued by the Cheyenne bank, there was a period of time in which the Omaha Branch actually held insufficient collateral to cover the war loan deposit of the bank at Worland. We accepted and held as collateral to war loan deposit of the Fourth National Bank in Wichita, Kansas, the custody receipt of the Chemical Bank and Trust Company of New York covering $3,000,000 in Treasury bonds. Shortly thereafter, the bank at Wichita requested that the securities be released as collateral as it was desired to effect a substitution therein. Upon receipt of the request from Wichita, the manager of our Fiscal Agency Department wrote the Chemical Bank and Trust Company asking that the release be effected, which the latter did, notwithstanding the fact that the manager of our Fiscal Agency Department was not among those authorized by this bank to effect a release of this kind. While the transaction may indicate Some carelessness in our Fiscal Agency Department in requesting that a transaction of this kind be made over an unauthorized signature, nevertheless it indicates also that the larger correspondent banks may not always be relied upon to L RESERVE BANK OF KANSAS CITY 41 Lay. 1948 Board of Governors of The Federal Reserve System Washington 25, D. C. follow fully the instructions in these situations. We thought it well to cite these two cases to further substantiate our view that the policy of accepting custody receipts from commercial banking institutions to be held as member bank collateral definitely does have some weaknesses. Yours very truly, Henry 0. KcticparIg / First Vice Presiden I FEDERAL RESERVE BANK OF KANSAS CITY KANSAS CITY 18, MISSOURI April e Q REC'D IN FMK.; SECTION 29, 1948 Board of Governors of the Federal Reserve System Washington 25, D. C. Dear Sirs: 2 2 'f?' 1 Reference is made to the Board's letter of April 5, 1948, requesting a statement of the views of this bank on the suggested procedure under which any Federal Reserve bank would accept as collateral security for a loan to a member bank custody receipts covering Government securities, in form satisfactory to the Reserve bank, issued by a member bank which in the usual course of business performs correspondent bank services for the borrowing member bank, including the holding in custody of Government securities. It is our view that there are several reasons which argue against the advisability and desirability of the suggested procedure. In the first place, the procedure would tend to minimize the importance and attractiveness of the safekeeping facilities of the Federal Reserve banks. While we recognize thRt there is a point in favor of making the credit facilities of the Reserve banks work as conveniently and expeditiously as possible, we are doubtful that it is necessary to accomplish this purpose by undermining another service of the Reserve banks which under present circumstances offers almost daily opportunity to demonstrate the value and usefulness of membership in the Federal Reserve System. The following tabulation shows by states the number of member banks in the Tenth District which at the time of a recent survey were utilizing the facilities of this bank and its branches for safekeeping of Government securities, direct and guaranteed: Number of Member Banks Using Facilities • Total Number of Member Banks 85 199 Totals 92 215 43 140 Colorado Kansas Missouri Nebraska New Mexico Oklahoma Wyoming 46 145 11 212 7 178 36 688 38 759 ,ERAL RESERVE BANK OF KANSAS CITY e • page 2 As these figures indicate, the member banks of this district are making most satisfactory use of our safekeeping service. The practice of keeping securities in the custody of correspondent banks presents no problem in this district, except in those cases, which appear to be relatively few, where banks in this district keep securities in custody of New York City correspondents. We feel sure that these few cases are adequately served by the arrangements under which securities in New York can be deposited with the Federal Reserve Bank of New York when the awning member bank needs to use them as collateral for loans by this bank. So far as the Tenth District is concerned we do not believe that the credit facilities of the Reserve bank would be improved in any material respect by publicizing the fact that we will accept the custody receipts of correspondent banks for securities pledged to us as collateral security for loans. On the other hand we think the announcement of such a policy would tend to depreciate the value of an important service which we now render to our member banks and would play directly into the hands of a few who argue against state bank membership in the Federal Reserve System by saying that city correspondents can do for country banks everything that the r'ederal Reserve bank could do. The suggested policy, if adopted, would supply a selling argument which some aggressive banks specializing in country bank business would use to the fullest extent in soliciting bank accounts and discouraging utilization of Federal Reserve bank services. Furthermore, the suggested procedure would pose for the Federal Reserve banks the difficult problem of selecting the member banks whose custody receipts would be deemed satisfactory. This problem might become complicated and a source of considerable embarrassment to a Reserve bank in event of changes affecting the continuing acceptability of a given member bank as custodian of the Reserve bank's collateral. Finally, we think the policy of permitting our collateral security for loans to be held in custody of commercial banks rather than in our own hands or the hands of another Federal Reserve bank would set an undesirable example which might prejudice the proper exercise of the bank supervisory function. It would seem undesirable to encourage the practice of making loans on the security of collateral which the lending bank will not have in its awn possession, since the risk is extended and compounded whenever that is done. If the Federal Reserve banks give publicity to a policy of making loans under such circumstances for their own account, our examiners will be under a substantial handicap if they undertake to criticize an unbusinesslike practice of a state member bank involving the same sort of procedure. After careful consideration we do not see advantages in the suggested procedure which outweigh its disadvantages and drawbarcks, and we therefore much prefer that the policy be not adopted. Ver . Leedy esident FEDERAL RESERVE BANK. OF CLEVELAND MAY b - CLEVELAND 1,0H 10 April 28, 1948 332. Board of Governors Federal Reserve System Washington 25, D. C. Dear Sirs: 7_ Reference is made to the Board's letter of April 5, 1948 regarding a proposed policy statement respecting acceptance by Federal Reserve Banks as collateral security for loans to member banks of custody receipts covering government securities, which custody receipts would be issued in each case by a correspondent bank of the member bank. We have considered such proposal and reviewed it with our counsel, and it is our preference that there be no change from the present policy, namely, that the Federal Reserve Banki -WiII Tai for reasonable plods custody receipts of responsible city correspondent banks as collateral for advances made to member banks where actual delivery of the securities is not convenient for the borrowing bank. This preference is based upon the considerations stated in the last sentence of the second paragraph of the Board's said letter of April 5, 1948 and also upon other considerations. It seems to us and our counsel that to make collateral loans generally on the basis of custody receipts rather than upon actual possession of the collateral tends to weaken the protection of the Federal Reserve Banks in that in some cases delays and difficulties in obtaining possession of the collateral may be experienced, which in rare cases might result in loss. For example, in the event of failure of pledging bank, immediate sale of collateral sometimes is advisable to avoid market loss or injunction against sale, or both. If possession of the collateral is not held by the Federal Reserve Bank there can be a delay in taking such action. Further, in the event of failure of the correspondent bank there would be of necessity some delay in obtaining possession of the collateral from the receiver of the correspondent bank, even if the collateral were intact, and if the collateral had been misappropriated there can be not only delay, but also litigation and even loss not only to the Federal Reserve Bank, but also to the pledging bank. In view of the foregoing, we favor retention of the present policy of accepting custody receipts as collateral to loans to member banks in appropriate cases and in our discretion. Sincerely yours, Ray M. Gidney, President 8 ..41,"1• EA REC ,r VICE f , HI INJ G TO N'ikiLl ER 14APR 28 PM 3 16 bOrGOVERNORS . OF THE FEDERAL RESERVE SYSTEM WA79G08BD WASH D12 CLEV 28-40b CARPENTER RETEL REPLY TO LETTER OF APR IL .5 RE THE ACCEPTANCE OF CUSTODY RECEIPTS AS COLLATERAL TO ADVANCES TO MEMBER BANKS MAILED TODAY. G I DNEY : 1311„.., 11Zzs oii - \CE. LE.NY:19' A948_ APR ,?.8 Boi\Ro EbERNL i\nA 10 tut 44 TIAE. S`fSIEM RESERVE WA31G7(BDW4SH J1G KC 28-93C) CARPENTER PRESIDENT LEEDY IS OUT OF CITY AND WILL RETURN TOMORROW. I AM SURE r HE WILL PROMPTLY FORWARD REPLY TO BOARD'S LETTER OF APRIL .)\ CONCERNING ACCEPTANCE OF CUSTODY RECEIPTS AS COLLATERAL TO ADVANCES TO MEMBER BANKS — JOHNS. TELEGRAM BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM LEASED WIRE SERVICE WASHINGTON April 27, 1948. Gidney — Cleveland Leedy — Kansas City We do not appear to have received your comments on the proposed policy statement set forth in the Board's letter of April 5, l94.8, re the acceptance of custody receipts as collateral to advances to member banks. CARPENTER (81411,FD) S. it, Carpenter FOR Pius A. L. Yates REC'D IN FIL,&; S6CTION MAY 5 - 1948 FEDERAL RESERVE BANK OF ST. LOUIS ST. Louis 2,MIS5OURI OFFICE OF THE PRESIDENT April 26, 1948 r. lerritt Sherman, Assistant Secretary Board of Governors of the Federal Reserve System ?lashington 25, D. C. Lear 3,1r. Sherman: -6, 72. 2.2, 5 Receipt is acknowledged of your letter of April 5 outlining the procedure suggested by the Board covering the acceptance by Reserve Banks of custody receipts of correspondent member banks as collateral to loans. 4e are of the opinion that the amount of securities the Reserve Bank of New York is willing to hold for member banks of this district under present arrangements will take care of our member banks' requirements for the foreseeable future. At the time the service was arranged for, it was agreed by the presidents that the practice would not be encouraged. That also was the position of the Boare of Governors, as I understood it. Consequently we have followed the practice of informing the borrowing banks who made inquiry, that the service is available, but we have not as yet circularized our member banks to that effect. That would seem to be the normal way to proceed to acquaint all member banks with the service. It is possible that when we advise all member banks of the availability of this service, the quota which the 1-;,eserve Bank of New York is willing to hold for our member banks will not be large enough to take care of the requirements of this district. In that event we would be willing to accept custody receipts of New York City correspondent banks. 7e do not anticipate that we would be called on to accept receipts of correspondent banks outside New York, and in our case would prefer that the practice be restricted to New York banks, at least for the present. Yours very truly, Chester C. Davis, President, PCi?Frr DI! REC1)IN 14"11,141,3 ;-iEceilON 47' "FARO OF GOVERNORS 41 2 547z :2) 3/:VY . - '14f3 OF THE FEDERAL RESERVE SYSTEM Office Correspondence To FILY9 From Date April 21, 1948. R. F. Leonard Subject: Mr. Rounds' letter of April 9 regarding the acceptability of custody receipts of member banks as collateral on borrowings from a Reserve Bank, concluded with the following paragraph: "In connection with the consideration of this matter, may we suggest that the Board explore the question as to whether or not member banks' collateral notes secured by custody receipts may be considered eligible as collateral for pledge of security against Federal Reserve notes. We pose this question because of the attitude of the Board Examiners in connection with certain other pledges of collateral." I called Mr. Rounds and asked him more specifically as to what he had in mind by the above paragraph. He said that from time to time the Reserve Bank made loans to member banks on the basis of telephone requests when it had the collateral in its possession. In such cases it would put a dummy note on the books until the actual note were received on the following day. As a matter of convenience, he said they had gotten in the habit of pledging everything and the examiners had raised the question as to whether such notes were proper collateral to Federal Reserve note issues. He said that the loaning officers of the Reserve Bank, while recognizing that there is not a close analogy between a dummy note secured by collateral in a Reserve Bank's possession and a bona fide note secured by custody receipt of a correspondent member bank, they nevertheless felt that there was sufficient similarity to raise the question. I told Mr. Rounds that I was glad to get this explanation and that I felt that it was desirable to have the whole Question clarified, both as to dummy notes and as to custody receipts. RFL:hlk FCT., 111"..11:3 , L. TfricC1,--- • t, f ; FEDERAL RESERVE BANK OF DALLAS REC'D MAY b194e ",- R.R.GILBERT PRESIDENT April 19, 1948 Board of Governors of the Federal Reserve System Washington 25, D. C. Attention: Gentlemen: Mr. Merritt Sherman Assistant Secretary , 7,n.2 2 tr6 We have given consideration to the Board's letter of April 5\ and to the suggested procedure outlined therein, under which the Federal Reserve banks would accept as collateral security for loans to member banks, custody receipts covering government securities issued by certain types of member banks. The objections which have been made by some of the Reserve banks to the acceptance of custody receipts as collateral seem to center largely around the administrative difficulties that might possibly arise if a Federal Reserve bank felt that it could reasonably and safely accept the receipts of one member bank and could not accept those of another. Also, the question has been raised as to whether a member bank's note, secured by a custody receipt covering government securities or other collateral, would be eligible as collateral security for Federal Reserve notes. Some of the Reserve banks have also expressed the view that the arrangement with the Federal Reserve Bank of New York for holding in custody government securities belonging to menber banks of other districts, when pledged to secure loans from the Reserve banks of their districts, is probably adequate for all practical purposes to meet the needs of their member banks. Vath respect to possible administrative difficulties, it is believed that these would be greatly minimized, if not entirely eliminated, if, as the Board has suggested, acceptance is limited to the receipts of member banks which in the usual course of business perform correspondent bank services, including the holding in custody of government securities, and to receipts which are satisfactory as to form. Of the government securities owned by the member banks of this district, it is believed that a relatively small amount is held in custody by banks other than those performing correspondent bank services, including the holding in custody of government securities, and that we would rarely, if ever, be offered • 2 the receipt of a bank that did not qualify in this respect. The competitive situation in this district is such that the possibility of our being offered a custody receipt of "the bank across the street" is very remote, even though the receipt might qualify in all respects under the suggested procedure. Our counsel has reviewed the provisions of law with respect to Federal Reserve note issues, collateral requirements, etc., and is of the opinion that a member bank's note secured by a custody receipt covering government securities or other eligible collateral, and issued in such form and under such agreement or agreements as to constitute a pledge of the government securities or other collateral, is a note that is eligible as collateral security for Federal Reserve notes. While the existing arrangement with the Federal Reserve Bank of New York is of great convenience to a large number of member banks, it does not permit the complete service and coverage that is contemplated under the suggested procedure. Moreover, the arrangement calls for the physical deposit of the securities with the Federal Reserve Bank of New York by the New York correspondent banks and the redelivery of such securities when the borrowing is retired. Should the suggested procedure be adopted, it does not appear likely that the arrangement with the Federal Reserve Bank of New York would thereafter be used to any extent or be needed. i All things considered, we are inclined to favor the adoption of the suggested procedure. We feel that the risks incident to its adoption are negligible and that it is desirable to provide a more convenient and less expensive means than is now available for member banks to borrow from the Reserve banks on their government securities. Otherwise, the banks might prefer to sell the securities in the market, probably at times when sales would not be desirable from the standpoint of System policy. If the procedure is adopted as a System matter, we think that it could be brought to the attention of member banks by circular letter in a way that would avoid encouraging the use of Federal Reserve credit when not in the interest of sound banking practice. Very truly yours R. R. Gi4ert Preside4t \ \ .1---, „ ,) • -.-,------72;r:---:--;:::--;-;—.7 ---I-A:L., FEDERAL RESERVE BANK OF SAN r RAN CI S C0 • 194P SAN FRANCISCO 20. CALIFORNIA 2 ) 4 ''' 1 ...) a( i April 16, 1948 Board of Governors of the Federal Reserve System, Washington 25, D. C. Dear Sirs: 25 The Boardts letter of April 5, 1948: reviews previous discussions with respect to the acceptance of custody receipts of city correspondent banks as collateral for advances made to member banks where actual delivery of securities is not convenient for the borrowing bank. The letter presents for consideration a procedure to be followed by the Reserve banks and asks for our views and also for comment on what steps should be taken to bring the proposed service to the attention of member banks. It is our opinion that certain safeguards and a reservation on the part of the Reserve Bank agreeing to the acceptance of such receipts within its discretion, would be desirable and would not detract from the value of the service. With the approval of our Board of Directors we have estab— lished a practice whereby trust receipts of the well recognized correspondent banks in the larger cities may be accepted in the absence of circumstances which might make it unwise to do so, if such action will avoid unnecessary cost or inconvenience to our member banks. We have prepared forms of agreement to be executed by member banks wishing to pledge as collateral to their bills payable government securities held by correspondent banks and an agreement to be executed by correspondent banks covering securities to be held in their posses— sion as pledge holders in such cases. Our current operating circular relating to discounts and advances provides that obligations of the United States or obligations of certain government corporations, etc., pledged as security for advances to member banks, should be lodged in an office of the Federal Reserve Bank of San Francisco unless other arrangements have been made in advance with the Reserve Bank. In addition to this circularization we are informing member banks orally, on the occasion of our scheduled visits, of the availability of this procedure. It is our feeling that the right to determine which bankts receipts we are willing to accept should not be impaired by any gener— alized statement to the effect that we shall accept unreservealTE5iTOY receipts issued by a member bank which in the usual course of business performs correspondent bank services, including the holding in custody of government securities for a borrowing member bank. Our opinion in this respect is strongly influenced by the existence, in this district Board of Governors of the Federal Reserve System -2- April 16, 1948 particularly, of affiliated member banks. The fundamental principle of independence of a custodian has long been recognized by the Board. Obviously, it could not be considered prudent banking to accept custody receipts of a bank as security to advances made to an affiliated institution. Relationship may vary from complete stock ownership control by a holding company to ownership of a minor amount of the capital stock or of a seeming close community of interests. It is our belief that avoiding a generalized statement, implying the acceptability of the custody receipt of any correspondent bank, will prevent the possible embarrassment of being compelled to state reasons for refusal to accept custody receipts when it is not felt advisable to accept such receipts because of a community of interest, or for any other reason. Another factor which influences our thinking regarding the possible hazards of a general announcement is that normally we see no need to accept trust receipts of correspondent banks situated in a city where there is an office of this bank. United States Government securities held locally can be delivered to us to be held as collateral without inconvenience or cost of any consequence, may be left with us in safekeeping when no longer needed and are then readily available for future pledge either for borrowing or as war loan collateral. They must be delivered to us eventually for redemption and probably also if sold before redemption. A further factor is our inability to determine readily whether the vault and accounting facilities of any bank whose receipt might be offered to us are adeouate to give the necessary protection. It is known that some banks which maintain correspondent bank facilities do not have vaults considered by us to be adequate to hold collateral against which we might make advances. It would be unfortunate for us to acquiesce in any way to the maintenance by any member bank of a safekeeping account in hands which might result in loss to our member bank, if not to the Reserve Bank. This subject has been discussed with our Directors, who feel that considerable discretion should remain with the Federal Reserve Bank with respect to where collateral pledged to it shall be held. In the light of these several objections we should much prefer to continue our present practice of informing banks during visits or when.discussing borrowing procedures with banks, rather than to give a foimal notice as broad as that set forth in the Board's letter. If, however, any formal announcement is to be made of the availability of this procedure it is our opinion that the second paragraph, as stated by the Board, should state that any Federal Reserve bank may, within it discretion, accept as ti collateral security Yours very truly, C. E. Earhart, President. , 4101 'D IN FILE::: SECTION. FEDERAL RESERVE BANK AY 6 194P 5 :3 3 c2.. ( OF ATLANTA OFFICE OF PRESIDENT April 16, 1948 Mr. Merritt Sherman, Assistant Secretary, Board of Governors of the Federal Reserve System, Washington 25, D. C. Dear Mr. Sherman: z In your letter of April 5, 1948 there was contained a proposed statement of policy with reference to Federal Reserve Banks accepting as collateral security to advances made to their member banks custody receipts covering Government securities issued by member banks which in the usual course of business perform correspondent bank services, including the holding in custody of Government securities, for correspondent banks. You request my views on the suggested procedure and also what steps, in my opinion, should be taken to bring the proposed service to the attention of the member banks. Since we originally suggested this method of accepting custody receipts in order to serve our member banks, I have little in the way of comment to add to that contained in our exchange of correspondence. In view, however, of your previous suggestions that this custody procedure should not be encouraged, it is my assumption that the majority of the member banks have not previously been informed of this service. Should my assumption be correct I believe it would be well to include in the first paragraph of your proposed policy statement an additional sentence to the effect that: The trial of this plan on a limited basis has proved successful and is now being augmented. While I concur with some of the other Presidents in their misgivings as to the acceptance of custody receipts issued by all member banks that perform usual correspondent services, including the holding in custody of Government securities for their bank customers, never-the-less, I feel strongly that we should assume the risks inherent in such a program. While we must exercise prudence, we cannot remain static and serve our members only in riskless transactions. When the statement of policy is in final form I believe AL RESERVE BANK OF ATLANTA Mr. Merritt Sherman -2- April 16, 1948 we should probably inform the Association of Reserve City Bankers of its contents prior to the time all of the members are informed. If the program is legally defensible, and I believe it so to be, then we should inform all member banks by letter of this method of serving them. Yours very truly, ,LA.XNN W. S. McLarin, Jr., President. , REC'D IN FILI.13 P EC'110N • MAY 5 - 14R 3 FEDERAL RESERVE BANK OF BOSTON April 15, 1948 Board of Governors of the Federal Reserve System Washington, D. C. Gentlemen: ' In response to your letter dated April 5, l98 concerning custody receipts of correspondent banks as collateral for advances to member banks, this bank recognizes the desirability of providing prompt and efficient credit facilities to our member banks and to this end we believe Federal Reserve banks that wish to do so should be free to accept custody receipts of responsible city correspondent banks. However, we question the advisability of permitting unrestricted use of this service and of gifing idIã It is reasonable to assume that the need for this service will vary among Federal Reserve banks depending to some extent upon their geographical location from New York. Presently there is little, if any, need for this service in so far as the banks in this district are concerned. We feel that available facilities are adequate to take care of the few cases which we may have involving loans to member banks in this district secured by collateral held by their New York correspondent banks. Approximately 91 per cent of all member banks in this district carry U. S. securities in our Safekeeping Department in amounts sufficient to take care of their loan requirements. The aggregate amount of U. S. securities presently carried for limber banks in our Safekeeping Department is approximately 1.3 billion dollars. It is our feeling that if the proposed procedure is adopted and given wide publicity, New York City banks will lose little time in campaigning for safekeeping accounts from member banks in this district. We understand generally that the cost or service fee charged by New York banks for safekeeping service is based upon the activity of the account in relation to the deposit balance carried. Establishment of the proposed service could result in a substantial switch of securities from this district to New York with an undetermined amount of transfer in bank deposits. Should the use of this service become country-wide, the tendency would be to increase centralization of funds in New York City. Furthermore, the expense, delay, additional work and inconvenience in the consummation of loans involving custody receipts must not be overlooked should the service become popular and widespread. Therefore, we would prefer that each Federal Reserve bank be free to accept custody receipts at its discretion but that no general publicip• be given to the plan, We believe it would be advisable to have a uniform custody receipt and generally that all transactions by Federal Reserve banks be handled on a uniform basis. Very truly yours, President 7 T,1; FEDERAL RESERVE BANK MAY 5 - 1948 (??: • 411 OF RICHMOND April 14, 1948 Board of Governors of the Federal Reserve System, Washington 25, D. C. Dear Sirs: This refers to your letter of April 5, 1948cPbout the '...cceptPnce of custody receipts as collateral for advances to membr banks. As indicated by the attached papers, this is a matter that gave me considerable concern over a period of several years. Although I agreed with the former position of the Board of Governors that the use of custody receipts of correspondent banks should not be encouraged, I secured conies of forms used by the Federal Reserve Bank of Atlanta and decided to recommend acceptance by our bank of custody receipts of New York correspondent banks if no other satisfactory program for relieving member banks of transportation costs could be devised. The first plan under which the Federal Reserve Bank of New York agreed to hold securities only for short periods in cases of emergency was helpful to some extent but WS not adequate for our needs. I, therefore, brOught un the matter for further discussion at the meeting of the Conference of Presidents held on June 4-5, 1947, and, as indicated on page 15 of the minutes of that meeting, the Conference requested the Committee on Fiscal Agency Operations and Reimbursnble Expenses to consider an arrangement permitting the telegraphic transfer of Government securities to secure loans by Reserve Banks. No action resulted from this reouest because at the next meeting of the Conference (October 3-4, 1947) Mr. Sproul presented a plan that fully meets our present and prospective needs. I }I've always thought and still think it is preferable for physical collateral to be in the possession of some Federal Reserve Bank. While there may be differences of opinion as to the degree of risk, I think it is obvious that there would be some risk in agreeing to accept custody receipts from all correspondent banks, and there would certainly be some danger of impairing existing bank relations if we should attempt to choose between banks. I see no reason to incur such 4 risks and dangers when we now have a plan that is adequate for the needs of -Ent's district. We do not believe thr't member banks in our district have been selling securities rather than borrowing to save, tranSportation costs, but as a precautiow.ry measure, it might be advisable for us to inform all of our member banks about the arrangement we have with the Federal Reserve Bank of New York. Our sole reason for not doing this in the past_ was to protect the Federal Reserve Bank of New York against abuse of its facilities. However, we now understand thEt, s far as this district is concerned, such protection Fe. T" 1(71q is not necessary. If it should be decided to adopt a plan such as that described in the Board's letter of April 5, 1948, we think the second paragraph should be changed in the fourth line to read ". .. any Federal Reserve Bank may also accept . ..." instead of ". . . any Federal Reserve Bank will also accept . . It • Very truly yours, HUGH LEACH, President. EnclosurPs: Excerpt from the Minutes of the Conference of Presidents June 18-19, 1945 Copy of letter from Hugh Leach to President Federal Reserve Bank of Boston, dated May 18, 1945 (Similar letters were written to the other Reserve Bank Presidents) Copy of Memorandum from J. S. Fry to Hugh Lech, dated May 18, 1gt5 'Copy of Memorandum from M. G. Ifiall:ce to Hugh Le; oh, dated April 5, 19/5 • EXCERPT FROM THE MINUTES OF THE CONFERENCE OF PRESIDENTS June 18 and 12, 1945 PaL)es 13-14 TRUST OR CUSTODIAN RECEIPTS Mr. Leach discussed the question as to the desirability of accepting trust or custodian receipts as collateral for advances by the Federal Reserve Banks, believing that the subject was of sufficient importance to bring it before the Conference. He had sent a memorandum dealing with this topic to each President. He informed that Reserve Banks are already accepting such receipts under authority of the Treasury for War Loan collateral. Several of the banks in his district have asked for permission to use these receipts as collateral for loans. The Richmond Bank has never done it, but Mr. Leach thought that it might do it now. It would eliminate the shipping problem, inasmuch as a large part of securities are kept in New York and the New York Reserve Bank is able to help out only in emergencies. Mr. Leach also said that the question as to whether trust or custodian receipts should be eligible as collateral for Reserve notes had not been passed upon by the Board of Governors. Mr. McLarin informed that the Board of Governors interposed no objection to the practice of using such receipts PS collateral for advances, but the Board does not encourage it. Mr. Sproul said that the question has arisen a number of times and, indspecial circumstances, the New York Bank has and would take the securities and issue a trust receipt. It might not be able to do it for all banks at all times, however, and he would prefer to have this' privilege extended only in special situations. There will always exist some possibility of loss or misappropriation of securities, so that he questioned any action in this respect that would become a fixed practice. Mr. Leedy stated that as a general rule member banks borrow on Government securities held in custody at his Bank and that he questioned the advisability of establishing a practice of accepting trust receipts. Messrs. Day and Young stated that the prevailing practice at their Banks is to lend only on securities held in their custody. Beyond discursion, no - c-tion was taken. FEDERAL RESERVE BANK ,ARY OF RICHMOND COPY May 18, 1945 Mr. Ralph E. Flanders, President, Federal Reserve Rank of Bocton, Boston 6, Wssachusetts. DeL.r Ra4h: Having suggested for consideration at the next meeting of the Conference of Presidents the topic *When lending on Government securities* is it desirable for e Federal Reserve bank to permit member and nonmember banks to deposit Government securities with custodians to be held subject to the order of the Federal Reserve bank rather than to require delivery of such securities to the Federal Reserve bank?" am enclosing two memoranda which bring out the various points I had in mind. You may wish to glance over them. Sincerely yours, HUGH LEACH, President. TC.17., FEDERAL RESERVE BANK OF RICHLIOND MEMORANDUM o: Mr. Hugh Leach, President From: J. G. Fry, Vice President Subject: Trust receipts covering U. S. securities as collateral for advances by this bank The Federal Reserve Bank of Richmond does not accept custodians' receipts commonly referred to as trust receipts as collateral for advances in lieu of the delivery of the collateral as I believe two or three other Federal Reserve banks have done at times. Since the Treasury authorized Federal Reserve banks to accept trust receipts covering collateral tendered for War Loan Collateral accounts, some member banks have asked if we would accept trust receipts issued by correspondent banks covering U. S. securities as collateral for advances. Such inquiries arc likely to increase in number. The extent to which banks in this district are making use of trust receipts in War Loan Collateral accounts is indicated by these facts: On April 30, 1945, the Federal Reserve Bank of Richmond held in War Loan Collateral accounts trust receipts for approximately 077,000,000 issued by 31 banks for the account of 178 banks. 28 of the 31 banks are member banks, 13 of which are located in new York City. The receipts issued by the 13 New York member banks covered 0363,000,000 of securities. The remaining C;14,000,000 were issued by 15 banks located in this district and 3 banks located in other districts. 104 of the banks for whose accounts we accepted trust receipts covering 70,900,000 of securities arc nonmember banks. The amount cf securities covered by trust receipts fluctuates with 'Car Loan deposits. For example, on December 19, 1944, trust receipts held in our V!car Loan Collateral accounts covered securities with a par value of !,d456,497,000. The attached memorandum dated April 25, 1945, from our Counsel states his opinion from a legal point of view on the question of accepting trust receipts covering collateral for advances by Federal Reserve banks and also on the authority of the Federal Reserve Agent to accept notes so secured as collateral for Federal Reserve notes. Since all Federal Reserve banks, under authority of the Treasury, accept trust receipts in 'Jar Loan Collateral accounts and one or two accept such receipts as collateral for advances, the Federal Reserve banks may wish to consider adopting a uniform practice in this respect. Generally speaking, member banks keep some of their Government securities in their own vaults, some with Federal Reserve banks in safekeeping, and some with correspondent banks, Extensive use is made of New York correspondent banks in this respect. The Federal Reserve Bank of Richmond accepts for safekeeping from nonmember banks only Treasury bills and certificates of indebtedness, which means that these banks probably make greater use of their correspondents in this respect than do member banks. In considering .;hether or not we should accept trust receipts as collateral for loans we stould take into account our obligation to lend to nonmember banks against direct obligations of the United States. If we accept trust receipts from member banks, could we afford to refuse to do the same thing for nonmember banks? • 2 Acceptance of trust receipts in lieu of a physical delivery of the collateral would save borrowing banks the heavy expense of handling and shipping securities held by their correspondent banks in cities other than Richmond, Baltimore, and Charlotte, and save the expense and trouble of transferring to us securities held by correspondents in these cities. It would cost the Federal Reserve Bank much less to handle trust receipts than it would to handle the securities. It appears that many banks place a portion of their holdings of Government securities in safekeeping with their New York correspondents. This is due no doubt to the excellent safekeeping facilities offered by them and to the fact that New York is the principal securities market of the country. However, the larger banks in this district that carry the accounts of other banks hold securities in safekeeping for their correspondents. It has been suggested that we accept trust receipts from Nev York Clearing House banks only. Such a plan might meet the needs of a large majority of our member banks, but could we fully justify such a practice when a number of our large member banks (including some located outside Reserve cities) hold for safekeeping securities belonging to their correspondents - both member and nonmember banks? Suppose Wachovia Dank & Trust Company of winston-Salem, N. C., should have $5,000,000 in U. S. securities with the Chase National Bank of New York, and offered that bank's trust receipt to be used by us as collateral for a loan to Wachovia. Acceptance of the receipt would be a service to Wachovia. But, if we refused to accept Wachovia's trust receipt offered by another member bank, or a nonmember bank, having securities in safekeeping with Wachovia, it would be very difficult to convince Wachovia that we were not discriminating against it - one of our own member banks. To say the least, we would be placed in an embarrassing situation. It seems, therefore, that we should not accept trust receipts issued by New York banks and refuse to accept such receipts issued by largo well-managed correspondent banks in our own district, especially if they have strong vaults. If we accept trust receipts issued by the large correspondent banks in nnston-Salem, Norfolk, Roanoke, Charleston, W. Va., and Charleston and Columbia, S. C., and other cities, on what grounds could we refuse to accept trust receipts issued by well-managed banks in other cities which hold U. S. securities in safekeeping for their correspondents? On what grounds could we refuse to accept trust receipts from a bank which carried its securities across the street to another bank and placed them in safekeeping to avoid shipping them to us? If we accept trust receipts covering securities owned by borrowing banks, we will doubtless be asked to accept their receipts covering collateral to their customers' notes offered to us for rediscount or as collateral for loans. During and for awhile after World War I we had many such requests, all of which were refused. If bank A's trust receipt issued for the account of bank B is acceptable to us, why would not bank A's receipt issued for securities belonging to its customer be likewise acceptable? • FEDERAL • SERVE BANK OF RICHMOND MEMORAND To: Mr. Hugh Leach, President From: M. G. Wallace, Counsel Subject: Discount of notes secured by obligations of the United States deposited by member banks with custodians and held subject to the order of a Federal Reserve bank I understand that you desire my comments on the above subject, particularly covering two points, the first, whether or not the Federal Reserve bank is adequately secured by the arrangement suggested, and, secondly, whdther or not the notes secured in the manner suggested may be accepted by the Federal Reserve Agent as collateral for Federal Reserve notes. I understand that the arrangement contemplated is as follows: A member bank desiring to borrow from this bank upon the security of obligations of the United States gives us its note in the usual form reciting that certain obligations of the United Stetee are pledged as security, and instructs some correspondent bank uhich has possession of the obligations thus pledged to hold them in custody subject to the order of this bank. The custodian then isms to us a receipt stating that the securities mentioned are held for our account and subject to our order. The Federal Reserve bank would, therefore, have at all times before the obligation of the member bank was paid the right to demand that the securities be delivered to it. In my opinion the transaction above creates a good and sufficient lien on the government obligations thus pledged. It is generally held that one of the essentials of a valid pledge is that the property pledged shall not remain in the custody or control of the pledger. Usually the most convenient way of excluding the custody or control of the pledger is to place the property in the hands of the pledgee. However, it is never held to be essential that the property shall be placed in the hands of the pledgee in person. The pledgee may select or approve a custodian to hold the property, and, when the property is placed in the hands of such custodian to be held subject to the order of the pledgee, the pledge is as valid and complete as if the property were in the direct custody and control of the pledgee. In other words, the custodian is the mere hand or instrumentality through which the pledgee maintains custody and control and excludes control by the pledgor. It will be seen from the above that the legal aspects of the ,elan under consideration are indistinguishable from those of the plan more commonly followed in which the securities pledged are delivered to this bank at one of its offices. The advantages and disadvantages, therefore, are dependent solely upon practical considerations. The obvious advantage is that the pledging bank may be able to avoid the expense and trouble incident to shipment of the securities which are probably already in the hands of the custodian. The disadvantage, aside from the possible obstacle to offering paper thus secured as collateral for Federal Reserve notes, is the chance of loss through the fraud or negligence of the custodian. Of course, in its legal aspects, the latter objection could be obviated to some extent by an agreement under which the pledging bank accepted absolute responsibility for securities in the hands of the custodian. If we make such an arrangement, an agreement to such effect would be desirable. • • -2 Since our blanket bond and the loss-sharing agreement botacon Federal Reserve banks protect us from losses of securities in any recognized place of safe deposit within the United States, these forms of protection would apply to all securities in the hands of a custodian and protect against many losses. This insurance, however, would not apply when, due to the fraud or mistake of the custodian, a receipt was issued . ehen no securities were in hand, or when securities were wrongfully delivered by the custodian to the plodgor or some other person under circumstances not amounting to theft or embezzlement. It seems to me that if the prqctice is adopted we should of necessity exercise discrimination in the selection of custodians. To approve one member bank as a custodian and decline to approve another would often cause ill feeling. On the other hand, to approve any member bank, wherever located, as a custodian rould be most imprudent. One possibility would be to approve certain banks located in New York, perhaps members of the New York Clecring House. This would be a logical distinction for a commercial bank to make. However, if made by this bank it might give rise to the charge that we had favored member banks in other districts at the expense of member banks in our own district which desired and were fitted to act as custodians. What I have said above concerning the legal aspects of this question when applied to the right of this bank as pledgee applies with equal force to the rights of the Federal Reserve Agent as pledgee. ',then we deposit an collateral for Federal Reserve notes the note of a member bank secured by a valid pledge of government bonds, the United States through the Board of Governors and the Federal Reserve Agent becomes the pledgee, and, as I pointed out above, the rights of a pledgee to the pledged collateral arc as complete when the collateral is held by a custodian for the account of the pledgee as they would be if the collateral were actually delivered to the pledgee. The possession of the custodian would sustain the pledge to the Agent just as effectively as it would sustain the pledge to us. However, the Federal Reserve Agent acting under the instructions of the Board of Governors would have the same right and the same or greater responsibility in the choice of a custodian as this bank has when it is a pledgee. The Federal Reserve Agent is required by law to maintain on the premises of a Federal Reserve bank an office of the Board of Governors of the Federal Reserve System. I believe that this provision of law contemplates that collateral for Federal Reserve notes will ordinarily be held by the Agent at his office. Since he acts as the local representative of the Board of Governors, in my opinion, he should not make any arrangement contemplating the keeping of the collateral elsewhere until such arrangement has been approved by the Board of Governors. I, of course, can venture no opinion as to whether or not the Board of Governors would approve the use of custodians. It seems to me, however, that it would be confronted by the same conditions which I mentioned above as applying to a Federal Reserve bank, and, indeed, would be more likely to be embarrassed by the necessity of discriminating between banks which wished to act as custodians. It is, of course, superfluous to point out that our right to discount a note of a member bank is in no way dependent upon the acceptability 3 of the note as collateral for Federal Reserve notes. So far as the law is concerned the discount of the note of a member bank and its subsequent tender as collateral for Federal Reserve notes are two separate and distinct transactions. I understand, however, that it is our practice uhenever we discount a note ':!hich is eligible as collateral for Federal Reserve notes to deposit the note with the Federal Reserve Agent, so that it may be the basis for issuing Federal Reserve notes whenever we desire them. While this practice is not essential, it is convenient, and I can easily see that it ,fould be most inconvenient to make a practice of discounting notes which are otherAse eligible as security for Federal Reserve notes but which cannot be accepted by the Federal Reserve Agent because of the form in which the collateral is handled. However, the advantages and disadvantages of the practice are dependent entirely upon our operating methods. In my conversation with you another point was raised casually, that is to say, whether or not a member bank which held the note of a customer secured by obligations of the United States might transfer the customer's note to us retaining possession of the obligations of the United States without affecting the lien. So far as any principle of law is concerned this, I think, may be done without in any way affecting the validity of the pledge. The possession of the pledgor who is the owner of the equity of redemption is excluded by the original deposit of the collateral with the member bank. Men the member bank transfers the note of the customer without the collateral the bank itself becomes the custodian of the collateral. So far as the legal aspect of the matter is concerned, it might be said that in such a case the member bank is the most preferable of all independent custodians, because it has a double interest prompting it to keep safely the collateral for which it is not only responsible as custodian but in the keeping of which it also has an independent interest. For practical reasons, however, I would not be disposed to recommend a policy under which member banks would be allowed to retain government bonds. If the bank became embarrassed, the very fact that it felt it had an interest in the collateral which it held might prompt it to make some improper use of the collateral while the notes for which the collateral was pledged were in our hands. Certainly it would be imprudent to adopt this practice in dealing Ath all member banks, and it would be even more difficult to discriminate than it would be if an independent custodian were employed. April 25, 1945 *) e e" 5_ / 7 ,, ,1 / 4 4---Ttr:4; ‘ • , ALL_ FILE::, : ( j 1 FEDERAL RESERVE BANK MAY 5 - 1948 OF MINNEAPOLIS OFFICE OF April 9 1948 ) THE PRESIDENT Mr. S. R. Carpenter, Secretary Board of Governors of the Federal Reserve System Washington 25, D. C. Dear Mr. Carpenter: ZZ We have given careful consideration to the letter of the Board of Governors dated April 5, 1948 which has reference to the custody by correspondent banks of Government securities pledged for loans made by a Federal Reserve bank. It is our view that it would be inadvisable to inaugurate such a practice except where the custodian bank is located in a city which has an important market for Government securities, viz., New York or Chicago. We have such an arrangement now, the borrowing member bank being located in Minneapolis and the custodian the Chase National Bank in New York. Our experience, however, indicates that only in exceptional instances will it be inconvenient for the borrowing member bank to keep the pledged securities with us. If the plan tentatively suggested in the Board's letter were promulgated in its present form, we assume we would be under compulsion to accept safekeeping receipts from any correspondent bank, wherever located. Such an announcemnt might result in correspondent banks soliciting our member banks which now carry their Government securities with us, to withdraw their securities and deposit them with such corres— pondents, whose safekeeping facilities may not always be satisfactory to us for various reasons. It seems to us that in cases of this kind, as in all cases where credit is involved, no general rules should be laid down but that the decision in each case ihould be left to the discretion of the discount , committee of the Federal Reserve bank involved. For that reason .we would not favor any statement on this subject to our member banks as we natelrb -guar—a—aate --EQt is not necessary and might be construed as a commitment which would prove embarrassing to us in some future banking 4 emergency. Several states in this District have statutory provisions which limit the right of state banks to pledge securities for loans, and we assume that such statutes are rather general throughout the country. Our attorney advises us that the general rule is that the validity of a pledge and the rights of the pledgee thereunder are determined by the • Mr. S. R. Carpenter, Secretary April 9, 1948 Page 2 laws of the state where the securities are at the time the pledge is made. It is evident that questions may arise in which there is a conflict of laws, and our attorney feels that the legal situation would become much more involved if we were to accept custody receipts for pledged securities from correspondent banks located in many different states. If it should be the view of the Board and of the other Federal Reserve banks that some general statement in connection with this subject should be issued to member banks, we would prefer to have the language of the second indented paragraph on page 2 of the Board's letter of April 5, 1948, revised to read as follows: "'bath a view to further improvement in the services of the Reserve Banks to their member banks and in order that their credit facilities may operate as conveniently and expeditiously as possible, any Federal Reserve bank may in its discretion accept as collateral security for a loan to a member bank negotiable Government securities owned by such member bank and held for its account by a correspondent bank in New York City or Chicago where such correspondent bank agrees to act as holder of the pledged securities by issuing a custody receipt which is satisfactory to the lending Federal Reserve bank." Should it appear expedient to add other Government bond centers to New York and Chicago, the wording "in a recognized Government bond market center, such as New York or Chicago", might be inserted for "in New York City or Chicago." JNP:B REt,;':66TIJ j;IT$ FEDERAL RESERVE BANK MAY 51948 OF NEW YORK NEW YORK L5 N.Y. April 9, 1948. Board of Governors of the Federal Reserve System, Washington 25, D. C. Gentlemen: - _2 cc-6 z This will acknowledge the Board letter dated April 5, 1948 referring to the discussion at the joint meeting of the Board and the Presidents on February 27, 1948, concerning the acceptability of custody receipts as collateral for advances made to member banks where actual delivery of securities was not convenient for the borrowing bank. The statement of procedure, as it appears on page 2 of your letter, seems satisfactory to us except that we would prefer to see the word "may" substituted for "will" in the fourth line of the second paragraph, or, if you prefer the word "will", to have inserted after that word the following: "in its discretion and for brief periods". With the excention of holdings of the New York City banks, substantially all of the securities owned by member banks in the Second Federal Reserve District are held in custody by us. Therefore, occasion would seldom, if ever, arise when this bank would be requested to accept a custody receipt in lieu of the actual securities as collateral to a loan to one of its member banks. In the circumstances, the subject is generally academic so far as we are concerned except in instances where we might be requested by another Federal Reserve Bank to accept on its behalf the custody receipt of a correspondent of one of its member banks in order that it may make an immediate temporary loan to such member bank against security of the receipt. We believe that the use of the custody receipts as collateral to temporary loans will be very helpful upon occasion and that they may properly be taken in lieu of the actual securities, provided the Federal Reserve Bank involved is satisfied to accept a custody receipt from its member's correspondent bank. Wa_!2ald be e etant to make any statement or to adopt a policy which -mig be construed as prescribing a rigid course of procedure or r:EDERA L RESERVE BANK OF NEW YOR 4101 1____t9ard of Governors 4/9/48. of the Federal Resellk System. as giving any borrowing bank the right to demand such a service. VTe believe the procedure to be followed in respect of the custody I the security for a loan should rest with the officers and irectors of the lending institution, who will be presumed to be amiliar with all of the factors involved. In connection with the consideration of this matter, may we suggest that the Board explore the question as to whether or not member banks' collateral notes secured by custody receipts may be considered eligible as collateral for pledge of security against Federal Reserve notes. We Dose this question because of the attitude of the Board Examiners in connection with certain other pledges of collateral. Very truly yours, L. R. Rounds, First Vice President. April 14, 1948 Tlr. Leonard: You will be interested in the last paraLrarh of this letter. G.B.V. • 4110,,e 1ON FEDERAL RESERVE BANK OF CHICAGO MAY 0 - 1948 2,'71 'd OFFICE OF THE PRESIDENT April 71 1948 Board of Governors of the Federal Reserve System Washington 25 D. C. Gentlemen; Attention Mr. Merritt Sherman , Reference is made to Board's letter of April 5concerning custody receipts covering Government securities held as collateral for loans to member banks. We have given careful consideration to the Board's letter and I have discussed this matter with Mr. Olson, our vice president in charge of loans. He has prepared a memorandum, copy of which is enclosed, which has my approval. Your attention is directed to the suggestion that if it is concluded to circularize member banks, they be advised that "this service is available for reasonable periods after a member bank has exhausted for collateral purposes Government securities held in safekeeping with its local Federal Reserve Bank." You will note that on April 1 this Bank held in excess of $241 million of custody receipts covering United States Government obligations pledged as collateral to loans. Very truly yours • • . rer ote-- O EMORANDUM • FEDERAL RESERVE BANK OF CHICAGO TO: FRO SUBJECT: Mr. C. S. Young, President M; DATE: April 7, 1948. A. L. Olson, Vice President Custody Receipts Covering Government Securities as Collateral for Loans to Member Banks. Reference is made to the statement of procedure concerning the above subject, as outlined in Board's letter of April 5. It is suggested: 1. That the proposed statement be amended so as to include a sentence reading as follows: "A member bank borrowing in this manner should accompany its application with a letter stating that the Federal is relieved of any liabilReserve Bank of negligence of the custodian bank." ity for the Such a provision would protect against the possible hazard of a correspondent bank accepting securities for safekeeping out of any reasonable proportion to its vault facilities. 2. That the word "may" be substituted for the word "will" in the fourth line of the second paragraph of the proposed statement. The proposed procedure should be resorted to only in exceptional circumstances when a member bank has exhausted for collateral purposes such Government securities as are held in safekeeping in the local Federal Reserve Bank. For this reason, it does not app!H_advisable to bring the proposed service to the attention of member banks. In the event, however, it is concluded to circularize member banks, it is suggested that the statement be further amended so as to provide: "The above service is available for reasonable periods after a member bank has exhausted for collateral purposes Government securities held in safekeeping with its local Federal Reserve Bank." Under present conditions, it would seem doubtful that many member banks would have occasion to pledge as collateral securities in safekeeping with their correspondent banks. Over the April 1 tax period, when the larger banks sus- -2- OAEMORANDUM • FEDERAL RESERVE BANK OF CHICAGO TO: FR SU BJECT: Mr. C. S. Young, President OM: DATE: April 71 1948 A. L. Olson, Vice President Custody Receipts Covering Government Securities as Collateral for Loans to Member Banks. tamed heavy deposit withdrawals, three of our Chicago member banks found it necessary to pledge as collateral custody receipts covering U. S. Government securities on deposit with their New York correspondents. As of that date we held in our collateral account custody receipts covering U. S. Government obligations aggregating $241,285,000. ty9, • h\Lic FEDERAL RESERVE BANK OF , MAY 51948 I2 PH I LAD E LPH IA OFFICE OF THE PRESIDENT April 7, 1948 Dear Sirs: z. In ;your letter of April 5, 1948, you requested the views of the Reserve Banks on the question of accepting custody receipts of correspondent banks representing government securities belonging to a member bank in order that such securities might be used as collateral for a loan. We have been accepting such receipts for more than three years and would accept any satisfactory receipts that are offered today - not only as security for loans but as collateral for the War Loan Deposit Account. As a matter of information, we are now holding several receipts of New York banks in our War Loan collateral. The problem in this district is greatly simplified for the reason that we have not been offered the receipts of any correspondent banks other than those of New York banks. Due to our proximity to New York, it is rather difficult to see why a member bank would deposit its securities in other than a New York bank, but if such an occasion should arise we would anticipate no difficulty and would be prepared to cooperate with our member bank. On the question of bringing this procedure to the attention of the banks in this district, we would have no particular objection to sending a general letter, would prefer to have our Bank Relations men aiscusi-it in their regular visits to the banks and also to make it a part of the general service discussions at our county meetings. In this way we would cover the district within a six months' period. bat-*e Very truly yours, tfilAym, Board of Governors of the Federal Reserve System Washington 25, D. C. e 1948 r‘pp - 5 Mr. W. S. McLarin, Jr., President, Federal Reserve Bank of Atlanta, Atlanta 31 Georgia. Dear Mr. McLarin: letterof March 5, l94A regarding This is with reference to yo issued by city loans by your bank as to which you accept custody receipts ment securities which are the basis correspondent banks covering the Govern for the loans. You refer to a loan Which your bank recently made to a member which the Savannah bank in Savannah, Georgia, against Government securities t, The Trust Company of Georgia, bank had deposited with its corresponden redeposited the Atlanta, Georgia. It appeared that The Trust Company had pondent, and under the Board's securities with its own New York corres to have The Trust letter S-1000 of November 25, 1947, you felt it necessary pondent and have that corresponCompany communicate with its New York corres n that the dent issue its custody receipt to your bank, indicating thereo securities were the property of the Savannah bank. You suggest that in such cases your bank would lee willing to t running from the dispense with the procedure of obtaining a custody receip and would be willing to accept, New York correspondent to the Reserve bank, a, .which receipt instead, a custody receipt of The Trust Company of Georgi security might be located. You would contain no reference as to where the t, which would amount state that your ability to accept such a custody receip y receipt, would be helpful in to a custody receipt issued against a custod promptly serving your member banks in a number of instances. ed to object In the circumstances, the Board would not be dispos such as you suggest in cases such as to your accepting a custody receipt te in the opinion you describe, provided such steps are taken as are adequa bank has a lien on the specific Governof your Counsel to assure that your any other Claimants. ment securities which will be fully effective against ple which is stated in section 8 of the In this connection the general princi Supp. 381, 383, Restatement of the Law of Security and quoted at 46 Fed. to the general effect that in order to would seem to be relevant. This is person rather than create a pledge where the property is held by a third must be notified. Although the delivered to the pledgee, the third person of a "fourth" rule is usually stated without regard to the possibility t who actnefly holds the bonds) person (here the New York corresponden 2 letters for approim4 Mr. U. S. McLarin, Jr. being involved, it mould seem to suggest the desirability of notifying such a "fourth" person if it is decided not to take a custody receipt running directly from such "fourth" person to the pledgee. Very truly yours, (S:GNED.) S. ft CARPENTER S. R. Carpenter, Secretary. For Approvti First of Mr Mr. :7 Mr. 9" 1ILW.. Pra "--.—...— Mr. Evans Mr. Vardanuta.., Mr. C1ayton-1--..... Mr. Thurston.-- ci If you approve, initial and return to Mr, Bredinan '''' PV,5 FS:ek 3/17/0 A Li 11 7 • BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM WASHINGTON 25, D. C. Z-2256 (On office copies only) ADDRESS OFFICIAL CORRESPONDENCE TO THE BOARD April 5, 1948. Dear Sir: At the joint meeting of the Board of Governors and the Presidents of the Federal Reserve Banks on February 27, 1948, there was a further discussion of the Board's letter of November 25, 1947 (S-1000), in which it was stated that it appeared to the Board that the Reserve Banks might properly accept for reasonable periods custody receipts of responsible city correspondent banks as collateral for advances made to member banks where actual delivery of securities was not convenient for the borrowing bank. At the meeting the Board expressed the view that it would be desirable that all Federal Reserve Banks follow the suggested practice, as a matter of System policy, in any case where the Bank would be willing to make advances to a member bank if the securities were deposited physically at the Federal Reserve Bank; that the credit facilities of the Federal Reserve Banks should be made to work as conveniently and expeditiously as possible; that failure to provide this facility might make it necessary at times for member banks, instead of borrowing on Government securities, to sell them in the market when such sales were not desirable from the standpoint of System policy; and that the new wire transfer facilities recently inaugurated would not satisfactorily meet this problem even if extended to include transfers of Government securities for use as collateral. Several of the Presidents appeared to concur in the view that to inaugurate a policy for accepting custody receipts from all correspondent member banks might present difficulties which could not be easily overcome once the arrangement was put into effect; that it might be unwise to accept custody receipts from some correspondent banks--for example, whore a correspondent bank was accepting securities for safekeeping out of any reasonable proportion to its vault facilities; and that it would be difficult to discriminate between correspondent banks in determining from which of them custody receipts would be acceptable. -2It vas understood th,t the Board would review the matter in he light of the discussion at the joint meeting and would submit a proposed policy statement to the Federal Reserve 3enks and that after the comments of the Banks were received a revised statement would be submitted to the Reserve Baliks for consideration. Pursuant to this understanding the Board now suggests a procedure which would be substantially as follows: The Federal Reserve 9arks in 1947, in recognition of the, existing practice of member banks of having securities held where they can be sold quickly, particularly in the N-3v York market, without incurring substential shipping charges, adopted a procedure under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securities, in limited amounts, belonging to a menbcr bank in Lnother Federal ReNerve district in order thet such securities might be used as collateral for o loan to such member bank by the Federal Reserve Bank of its district. This procedure reauires the physithe Federal Reserve Bank of cal deposit of the securities Now York and their redelivery to the New York correspondent bank when the need for borrowing by the member lxnk his passed. With a view to further ioaprovenent in the services of the Reserve Banks to their member immks eald in order thot their credit facilities moy operate as conveniently ind expeditiously as possible, any Federal Reserve Bank ijili also accept as collateral security for e loan to a member bank custody receipts covering Government securities, in fora satisfactory to the Reserve Bonk, issued by a malber bank which in the usual course of business performs correspondent hank services, including the holding in custody of Government securities, for the borrowin A member brnk. In accordance with the understending at the joint meeting on February 27, it will be appreciated if you will give the Board the benefit of your views on this suggested procedure and also on vhrt steps should be taken to bring the proposed service to the attention of member banks. After the coments of 111 of the Presidents have been received, a revised statement of procelure iil1 be preprred and sent to rll of the Federal Reserve Banks. Very truly yours, •••-t.,,C" V-N.J.,‘ Merritt Assistrnt TKS TO THE PSIDENTS OF ALL FEDERAL RESERVE BlAii, ary. APR - 5 1944 , Dear Sir: At the joint meeting of the Board of Governors and the Presidents of the Federal Heserve Banks on February 27, 1948, there was a further rAscussion of the Board's letter of November 25,1947 (S-1000), in Which it was stated that it appeared to the Board that the Reserve Banks elight properly accept for reasonable periods custody receipts of responsible city correspondent banks as collat— eral for advances liade to member banks where actual delivery of securities was not convenient for the borrowing bank. At the meeting the board expressed the view that it would be desirable that all Federal Reserve Banks follow the suggested practice, as a matter of System policy, in any case where the Bank woad be willing to make advances to a memser bank if the securities . were deposited physically at the Federal Reserve Bank; that the credit facilities of the Federal Reserve Banks should be made to work as conveniently and expeditiously as pessisle; that failure to provide this facility might make it necessary at times for member banks, instead of borrowing on Government securities, to sell them in the market when such sales were not desirable from the standpoint of System policy; and that the new wire transfer facilities recently inaugurated would not satisfectorily meet this problem even if ex— tended to include transfers of Government securities for use as collateral. Several of the Presidents appeared to concur in the view that to inaugurate a policy for accepting custody receipts from all correspondent member banks mijet present difficulties wich could not be easily overcome once the arranp,e!,ent was put into effect; that it might be unwise to accept custody receipts from some correspondent banks--for example, where a correspfndent bank was ac— cepting secerities for safekeeping out of any reasonable proportion to its vault facilities; and that it would be difficult to discriminate between correspondent banks in determining from which of them custody receipts would be acceptable. It was understood that the Board would review the matter in the light of the discussion at the joint meeting and would submit a t ED) 00 C io 0,.c.1.07y1 Ej 1 -2pr posed policy statement to the Federal Reserve Banks and that after the comments of the Banks were received a revised statement would be submitted to the Reserve Beaks for consideration. Pursuant to this understanding the Board now suggests a procedure which would be substantially as follows: The Federal Reserve Banks in 1947, in recognition of the existing practice of member banks of having securities held where they can be sold quickly, particularly in the New York market, without incurring substantial shipping oharges, adopted a procedure under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securities, in limited amounts, belonging to a member bank in another Federal Reserve district in order that such securities might be used as collateral for a loan to such member bank by the Federal Reserve Bank of its district. This procedure requires the physical deposit of the securities with the Federal Reserve Bank of New York and their redelivery to the New York correspondent bank when the need for borrowing by the member bank has passed. With a view to further improvement in the services of the Reserve Banks to their member banks and in order that their credit facilities may operate as conveniently and expeditiously as possible, any Federal Reserve Bank will also accept as collateral security for a loan to a member bank custody receipts covering Government securities, in form satisfactory to the Reserve Bank, issued by a member bank whioh in the usual course of business performs correspondent bank services, including the holding in custody of Government securities, for the borrowing member bank. For Approval i\• First of Mr. Szymesak Mr. Draper Mr. Evans Mr. Vardaman Mr. Clayton... Mr. Thurston. 00000 ••••••••••• If you approvel4 • initial and ret' IP n " Mr, Brerr an la accordance with the understanding at the joint meeting on February 27, it will be appreciated if you will give the Board the benefit of your views on this suggested procedure and also on what steps should be ken to bring the proposed service to the attention of member banks. After the comments of all of the Presidents have been reoeived, a revised statement of procedure will be prepared and seRt to all of the Federal Reserve Banks. 6 Very truly yours, Nignedi Norritt Sherman Assistant Secretary. TO THE PRESIDENTS OF ALL FEDERAL RESERVE BANKS SRC/CM:jbs c i yiss ."*$ • • t: A PP ; - 1`j1ZIR Dear Sir: At the joint meeting of the Board of Governors and the Presidents of the Federal Reserve Banks on February 27, 1948, there was a further discussion of the Board's letter of November 25, 1947 (S-1000), in which it was stated that it appeared to the Board that the Reserve Banks might properly accept custody receipts of responsible city correspondent banks for reasonable periods where actual delivery of securities is not convenient for the borrowing bank, and that the Board believed that this pracrice might enable the Reserve Banks to be of greater service to their member banks. The matter was placed on the agenda for the joint meeting for the reason that some of the Presidents, at the meeting of the Presidents' Conference on December 8, 1947, did not favor the acceptance of such receipts. , At the meetinc on February 27, the Board ex- pressed the view that in order to afford a desirable service to member banks and to avoid unnecessary shipments of securities with the attendant costs and delays, the Federal Reserve Banks should follow the practice of accepting custody receipts in satisfactory form from correspondent banks and loan on the security of such receipts in any case in which the Federal Reserve Bank would be willin to make the loan if the securities were deposited physically at the bank. The reasons fo2. the Board's view are set forth in a draft of the minutes of the joint meeting, a copy of which you have. A majority of the Presidents )1\i -2— were of the opinion that to accept custody receipts from all correspondent member banks might present difficulties which would not be easily overcome and two of the Presidents stated that the arrangement established last year under which the Federal Reserve Bank of New York accepts the deposit of securities, held in custody by a New York correspondent bank for the account of a member bank in another district, as collateral security for a loan by the Federal Reserve Bank of the district in which the member bank was located, adequately met the problem and that the further step proposed by the Board was unnecessary. It was understood that the Board would review the matter in the light of the discussion at the joint meeting and would submit a proposed statement to the Federal Reserve Ranks for comment, after which a revised statement would be submitted to the Reserve Banks for consideration. Pursuant to this understanding the Board now suggests a procedure which would be substantially as follows: The credit facilities of the Federal Reserve Banks should operate as conveniently and expeditiously as possible and without unnecessary restrictions. They should also take into account, when con- sistent with the policies and operating procedures of the Federal Re,44 ( serve Ranks, the practice of member banks of holding securities where they can be sold quickly without incurring expensive shipping charges. In recognition of this practice, the Federal Reserve Banks in 1947 adopted an arrangement under which the Federal Reserve Bank of New York agreed to accept the deposit of Government securities belonging to a member bank in another Federal Reserve district in order that such securities might be used as collateral for a loan by the Federal Reserve Bank of the -3district in which the member bank was located. This arrangement requires / e the actual deposit of securities with the Federal Reserve Bank4 and their redelivery to the New York correspondent bank when the need for borrowing by the member bank is passed. In order further to improve the services of the Federal Reserve Banks to their member banks they will also accept as collateral security for loans to member banks custody receipts in form satisfactory to the respective Federal Reserve Bank covering Government securities issued by the member banks in principal cities which, in the usual course of business, perform correspondent bank services including the ho ding in custody of Government securities for Its c rrespondenanks. Each Federal Reserve Bank will take such steps as it may deem necessar: to assure that member banks will be aware that they 7ay borrow on the security of custody receipts of the kind referred to above and will not have to sell the securities in order to get needed reserve funds. In accordance with the understanding at the joint meeting on February 27, it will be appreciated if you will give the Board the benefit of a full statement of your views on this suggested procedure. After the comments of all of the Presidents have been received, a revised statement of procedure will be prepared and sent to all of the Federal Reserve Banks. Very truly yours, S. R. Carpenter, Secretary. TO THE PREMENTS OF ALL FEDERAL RESERVE BANKS Dear Sir: At the joint meeting of the Board of Governors and the Presidents of the Federal Reserve Banks on February 27, 1948, there was a further discussion of the Board's letter of November 25, 1947 (S4000), in which it was stated that it appeared to the roard that the Reserve Banks might properly accept custody receipts of responsi— ble city correspondent banks as collateral for advances made to member banks, for reasonable periods where actual delivery of securities is not convenient for the borrowing bank. At the me-ting the Board expressed the view that it would ho desirable that all Federal Reserve Ranks follow the suggested practice, as a matter of System policy, in any cal where the would A be milling to make advances to rieber banks/ if the securities were / A deposited physically at the Federal Reserve Bank! that the credit facilities of the Federal Reserve Banks out414—to be made to work as conveniently and expeditiously as possible; that failure to provide this facility might make it necessary at times for member banks, instead of borrowing on Government securities, to sell them in the market when such sales were not desirable from the standpoint of System policy; and that the new wire transfer facilities recently inaugurated would not satisfactorily moot this problem even if extended to ino ude transfers of Government seourities for use as 6 .46e collateral. One—r—mare of the Presidents expressed the view that -4 Gova-oli -0:100 . •1 11,‘ a to inaugurate a policy for accepting custody receipts from 411 corre4 spondent member banks 4ht present difficulties which could not be OW on; that it'lAght be unwise to accept custody easily o receipts from some correspondent banks—for example, where a correspondent bank was accepting securities for safekeeping out of any reasonable proportion to its vault facilities; and that it would be difficult to discriminate between corresiondent banks in determining from which of them custody receipts would be acceptable. Towardir-the end of the discuasion at the joint meeting on Fellruary- t-mus-auggeste&-that -the matter be placed on the agenda for-dIe-camwtaft at a later- meeting-en- the bastirof a memorandum which , f.he- reagens-for and-against_tho proposal.-would_state-thc-pze].lar ! 4 Tho Board agrapd-thaibmit would review the matter in the light of the discussion at the joint meeting and would submit a proposed policy 1. % statement to the Federal Reserve Banks for----e-emr..crre4 .,after, vildish I. ..;? a revised statement would be submitted to the Reserve Banks for con. sideration. Pursuant to this understanding the Board now suggests a procedure which would be substantially as follows: The credit facilities of the Federal Reserve Banks should operate as conveniently and expeditiously as possible and without unnecessary restrictions. They should also take into account the practice of member banks of holding securities whore they can be sold quickly without incurring substantial shipping charge°. In • 40440 recognition of this practice, the Federal Reserve Banks in 1947 adopted an ttrrangement under which the :Axiom' Reservo 4rtnl: of 1, 1ow York agreed to accept the deposit of Govornnont securities belonging to a member bank in another Federal Reserve district in order that such securities mig6L used as collateral for a loan by the Federal Reserve Dank of the district in which the member hank was located. This arrangement requires the physical depoolt of securi- ties with the Federal Reserve :;ank and their re-delivery to the Now York correspondent bank when the need for borrowing by the member bank has passed. In order further to improve their service to member banks, Federal Reserve ranks will also accept as collateral eecurity for loans to member banks custody receipts covering Government securities in form satisfactory to the respective Federal Reserve flanks, issued by member banks which, in the usual course of business, perform corresporWent bank services including the holding in custody , 44-tc4el-tti of Government securities for the al Reserve Bank will .notify'aueh of ita-member banka aa boora_heretol. fore made inquiry in regard thereto that they may borraKeon the. security of custody receipts of the kind referred to above.) In accordance with the understanding at the joint mooting on February 27, it will be appreciated if you will give the Deara the benefit6f—Er 11 -slatemen+f your views on this suggested OM procedure. Li. MI After the comments of all of the Presidents have been received, a revised statement of procoduro will be prepared and sent to all of the Federal Reserve Banks,to-ife, ;42;sed.,Avt--e-iyettriipterf - frr tQtaon-z-t-the-nex,t--Conferenoe- of - PrealcitemetwcVery truly yours, S. R, Carpenter, Secretary. TO THE PRESIDENTS OF ALL FEDERAL RESERVE BANKS. (3-11-48) Dear Sir; At the joint reeti,L, of the aoard of Governors and the Preeidents of the Federal Reserve 3arlo on February 27, 194E, there wae a further discuesion of the Wardle let er of November 5, 1947 (S-1000), in which it wae stated that it appeared to the Board that the Reacrve nieht oroperly accept custody receipts of reeponsi- : ble city correspondent , eanka as collateral for advances made to memeer banks, for reasonable periods where actual delivery of securities is not ccmvenient for the borrowing bank. ,Jed the view that it would At the meeting the Board expret. be desirable tnet all Federal Reuerve banke follow the suggested prhctice, a matter of Syetem policy, in any case where the bank would be will3nz to make advances to a member bank if the securities were deposited phyeically at the Federal Reserve Dank; that the credit facilities of the Federal Reeerve Isanke should he made to work as cenveniently and expeditiously aa pissible; that failure to provide this facility mieht nake it necessary at times for member baeas„ inotead of borrow ng on Government securities, to sell them in the market when such sales were net desirable from the standpoint of Syetem policy; and that the new wire transfer facilities recently inaul;urated weuld eot satisfactorily meet this problem even if extended to include trensfere of Government Lecuritisefor uae as collateral. Several of the Preeieents appeared to cencur te the view that to inaueurate a policy for accepting custody receipts from all correspou(lent member banks might present 'F.1. 110 ettitav,000. Gotao-o. difficulties lelich ceuld not be easily overcome once the 4rraneeent was put into effect; that it might lee unviee to eecept cuetody rece4 from eome correeeondent bas. -for examples where a correspendent beak was accepting securities for sefeeeeping out of any reueenable propor. tion to its vault facilities; arei that it eeeuld be iiffieult to diø.. cririnate between correepondent banks in determinine from which of them custody receii;te weulci be acceptable. It wee understood that the Poard would review the mateer in the light of the discueeion at the joint meeteig and would submit a proposed policy statement to the Federal Reserve Banks and that after the cornents of the Banks were received u revised stetemant submitted to the Reserve :aanes for consideration. Purcuant to thie understanding the Board now eu,ests a procedure which would be subtille es followes The credit fecilitiee of the Federal Reserve an should operate its conveniently and expeditiously as poseible and without unneceeeery restrictions. They should alto take into ecceunt the practice of member banks of holethag securities where they can 'oe sold quickly out incurring eubstaetial shipping charges. In recogniton of this prectice, the Federal Reserve Banes in 1947 adopted an arraneement under seUch the Federal Reaarve Bank of New York ao-ceri to accept the deToeit of Government eecurities beloni;ine; to a eember baek in another Federal Reserve !Istrict in order that such eecurities ray be used ae collateral for a loan by the Federil Reserve Pan'e of the dietrict in which the member -3 bank is located. This arrangement requires the physical depol-;it of securities with the Fedeml Reserve Banar their re-delivery to the Ne,T York correspondent bank when the aced for borrowing by the member bank has pased, , . In order Airther tc improve their tli rvice to membsr bahks, Federal Ressrve .&lrC4: , . will also accept as collateral sec, trity for loans to member banks custody 'receipts covering Gowrnment ecuri- 1serve Banks, ties to, form satisfctory to the respectivo Federal . 1 1 issued by member banks which, in the usual course of .7usiness, perform correspondent bank services 1acludia6 the holding in custody of Government securities for the borrow:ng member bank. 4044..-144.eral Relierve Bank 1411 take jt ragtr_titti4 necetdaFxr:;. to Lt&i a..liure-that-Inember-hftn;(e.mill-be 844a-re-that-they may-borrow-om-t44security.of-onatady- receipts...of.. the1:ind-referred to al-Jole end-wiLk , , not have to-sell-the-aecuritieo in-orler-to-get nreded regery* Inads. In accordance with the understanding at the joint raeng. on February 27, it will be appreciated if you will Give the ,'Ikt.ard the benefit of your views on this oug.osted procedure" After the coments . revised strIterent .of of all of the President$ have !leen received,„„&v Jd2rocednre will be propared a, tient to all of the Federal RefJervo Banks. - cry truly yours, 0, &th EL t.4414''" V S. R. Carpenter, secretary. I i TO TUE PRESIDENTS OF ALL FFDEPAL RESZ,RVE VANKB. ...... 1 .i... ••••,"•• .. , 4 40- r ' C D IN ir'i t,fr: ,- .' ) :,ci:03 . I\1 RE •ARD OF GOVERNORS 410,PR 6 - OF THE 948 I 1 FEDERAL RESERVE SYSTEM Office Correspondence To General Files From Mr. Solomon Date Subject: Mnrch 17 1948 Lending on securities held by "fourth" person. The letter of larch 5, 1948 from Er. McLarin, President of the Federal Reserve Bank of Atlanta, raises the question whether that Bank may make loans on Government securities where the bank does not actually hold the securities or even a custody receipt for the securities, and has only what amounts to a custody receipt issued against a custody receipt for the securities. It is a settled general rule that delivery of the article ledged is essential to the creation of a pledge. Restatement of Law of Security, section 5. This is based on the general principle that the pledger should not be left in a position where he may be able to mislead others into believing he is still the full owner of the property. A well recognized exception to the general rule is to the effect that such delivery is not necessary if the property is in the hands of a third person and the third person is notified of the pledge. Restatement, Section 8. (See also cases cited in memo of Mr. Chase to General Files dated December 20, 1944, on "Pledge of Securities Held 'lsewhere", General File 332.4), The Restatement, section 8, illustration 1, illustrates the need for notification as follows: "1. A agrees with B that a chattel in the possession of C is to be security for an indebtedness of A to B. Before C is notified the chattel is attached by D, another creditor of A, who has no notice of the agreement. The attaching creditor has priority because no pledge is created before notification." While the cases do not fully spell out the reasons for the requirement of notification in such cases, it apparently is based on the general idea of formalizing the arrangement and preventing secret liens. (It is, of course, more satisfactory to obtain a new custody receipt running directly from the third person to the pledgee as outlined in S-1000. Restatement, section 8, Comment A.) A fairly extenqve search has revealed no cases dealing precisely with the question of a "fourth person bailee (the New York correspondent who actually holds the securities in the Atlanta question) as contrasted with a "third" person bailee. It could perhaps be argued with some logic that notification to the "fourth" person is not essential since the pledger has been effectively deprived of dominion over the property by notification to the "third" person (or obtaining a custody receipt directly from the 'third" person). There is, however, no assurance that a court would be willing to accept this argument and narrow the principle in this way. Accordingly it would seem to be the part of wisdom for the Reserve Bank to notify the "fourth person, if the Reserve Bank does not wJ13.-40 go so far as to obtain a custody receipt running directly to it fro "fourth" person. oa 1,07. c ov(1°11 i - -AA-2LAC:44441-1-',, FEDERAL RESERVE BANK OF ATLANTA OFFICE OF PRESIDENT March 5, 1948 Board of Governors of the Federal Reserve System, Washington 25, D. C. Gentlemen: During the joint meeting of the Board of Governors and the Presidents in Washington last week considerable discussion was held regarding Board's letter S-l000, dated November 25, 1947, concerning the acceptance by Federal Reserve Banks of custody recelpts issued by city correspondent banks covering securities pledged for loans which a Reserve Bank makes to its member banks. It was apparent that the Board felt this service should be expanded to include custody receipts issued by member banks located outside of New York City. I should appreciate being informed, in view of the discussion mentioned above, if the Board would be willing to approve our acceptance of custody receipts issued by the Trust Company of Georgia, Atlanta, Georgia, covering securities owned by member banks, such securities having been placed with the Trust Company of Georgia for safekeeping and in turn placed in New York City for safekeeping for the account of the Trust Company of Georgia. If -Lie Board of Governors would be agreeable to such a handling the Federal Reserve Bank of Atlanta would be willing to accept custody receipts issued by the Trust Company of Georgia to the Federal Reserve Bank of Atlanta, which receipts would contain no reference as to where the securities might be located. Our ability to accept a custody receipt which was issued against a custody receipt would be of material aid in quite a few instances in promptly serving our member banks. As an example, we had a transaction this week which would have been expedited if it had been possible to accept a custody receipt issued by the Trust Company of Georgia. This transaction was as follows: A Savannah, Georgia, member bank desired to borrow $500,000.00 from us and requested its correspondent, The Trust Company of Georgia, Atlanta, Georgia, to deliver to us the collateral Government securities. The Trust Company informed us the securities AAL RESERVE BANK OF ATLANTA Board of Governors of the Federal Reserve System March 5, 1948 were held by the Trust Company's New Y6rk correspondent for the account of and subject to the order of the Trust Company. It was necessary, therefore, for us to request the Trust Company to communicate with its New York correspondent and have that correspondent issue its custody receipt in favor of and subject to the order of the Federal Reserve Bank of Atlanta, indicating thereon that the securities were the property of the Savannah bank. Your consideration of this request will be appreciated. Yours very truly, W. . MCLari President. n/Le _ - <1 . ;:. A ( , r . REM /FILES SECTION 1 MAR 18 1948 1e t. ustody Receipts for Collateral Securing Loans to Member Panics. _ 4-/ In order to afford a desirable service to member banks and to avoid unnecessary shipments of securities with the attendant costs and delays, it is important that all Federal Reserve Banks follow a policy of accepting custody receipts4trom correspondent member banks and loan on the security of such custody receipts in any case in which the Reserve Bank would be willing to make the loan if the securities were deposited physically at the Bank. The credit facilities of the Federal Eeserve Syste_11 should be made to work as conveniently and as expeditiously as possible and without unnecessary restrictions. The additional risk involved in acceptance of custody receipts is believed to be nominal and is more than outweighed by the convenience of the arrangement. Failure to provide this facility for member banks may mean in some instances that the banks, instead of borrowing on Government securities, will sell the securities in the market, when it is not desirable for them to do so from the standpoint of System policy. The new wire transfer facilities, even if extended to include transfers involving use of Government securities as collateral for advances, would not satisfactorily meet this problem. 2 74 /2 / 8 • RL t, IN FILES SECTION SEP 8 1953 Custody receipts for collateral securin7, loans to member banks ..101••••••••••••• Mr. Leach read to the meeting the letter dated January 29, 1948, received by the Chairman of the Conference from the Board, requesting that the matter of eestody receipts for collateral securing loans to member banks be placed on the acenda of the Conference for discussion at the joint meeting of the presidents and the Board. He referred to the consensus at the meeting of the Conference of December 8, 1947, that "any Reserve Bank which wishes to do so should be free to ceipts of responsible city correspondent banks but that the accept the custody r, practice of receiving such receipts from correspondents should not be encouraged" (mins., p. 10); and he reported that the Committee on Operations knows of no reason for reaching a different conclusion at this time. Durine: the discussion which followed, it was pointed out that since the meeting of December 1947, the only chenge in the situation which has occurred, to the knowledge of the presidents, is the proposed institution of a procedure for the wire transer of Treasury bonds commencing March 1, 1948, which will tend to lessen rather than increase the need for the use of custody receipts. The Conference, therefore, saw no reason to depart from the consensus of the December eighth meeting. It was understood, hmever, that after there has been sufficient experience with the more inclusive wire transfer facilities now to be made available, the Committee on Fiscal Agency Operations and Reimbursable Expensee would explore with the Treasury Department the possibility of further extending the wire transfer facilities to include transfers of Government securities for use as collateral for advances.by Reserve Banks. a, REC'D IN FILES SECTION SEP 1 71953 4. Custody receipts for collateral securing loans to member banks. In its letter of January 29, l?48, the Board of Governors requested that this matter be placed on the agend a for the next Presidents Conference for discussion at the joint meeting of the presidents and the Board. The Conference, at its meeting on Decem ber 8, 1947, agreed that, "any Federal Reserve Bank which wished to do so should be free to accept the custody receipts of responsible city correspondent banks, but that the practice of receiving such recei pts from correspondents should not be encouraged". Since that meeting the only change in the situation which has occurred to the knowledge of the Conference is the Proposed institution of a procedure for the wire transfer of Treasury bonds commencing Earch 1, 1948, which will lesson rather than increase the need for the use of custody receipts. The Conference, therefore, saw no reason to depart from the consensus of the December 8 meeting. However, the Conference proposes to explore with the Treasury Department, when sufficient experience with the new wire transfer facilities has accumulated, the question whether the facilities for telegraphic transfer can not be extended to include trans fers involving use of Government securities as collateral for advances at Feder al Reserve Banks. 27 Chairman Eccles stated that the Board had considered the presidents, statement, but felt that in order to afford a desirable service to member banks and to avoid unnecessary shipments of securities with the attendant transit delays, it was important that all Federal Reserve Banks follow a policy of accepting custody receipts in satisfactory form from correspondent member banks and loan on the security of such custody receipts in any case in which the Reserve Bank would be willing to make the loan if the securities were deposited physically at the Federal Reserve Bank, He also stated as the view of the Board that the credit facilities of the Federal Reserve Banks should be made to work as conveniently and as expeditiously as possible and without unnecessary restrictions, that the additional work involved in the acceptance of custody receipts was believed to be nominal and was more than outweighed by the convenience of the arrangement, that failure to provide this facility for member banks might mean in some instances that the banks instead of borrowing on Government securities would sell the securities in the market when it was not desirable for them to do so from the standpoint of System policy, and that the new wire transfer facilities even if extended to include transfers involving the use of Government securities as collateral for advances would not satisfactorily meet this problem. Mr. Peyton stated that such a policy would contemplate that the Federal Reserve Banks would accept custody receipts from all correspondent member banks, and that, although his Bank had adopted the practice of accepting such receipts from some banks, he would not want to accept them from banks about which the 7ederal Reserve Bank had information which would indicate that it would be unwise for the Bank to do so, Chairman Eccles stated that it was not the intention of the Board to say that the receipts should be accepted from every correspondent bank if there were any satisfactory reason for not doing so, but that the only case in which the Federal Reserve Bank might suffer a loss would be one in which there was dishonesty on the part of the correspondent bank, and that if the correspondent banks were satisfactory as depositories or custodians for other member banks there should be no objection to the acceptance of their custodian receipts. Mr. Peyton raised the question of a case where a small correspondent bank might accept for safekeeping securities out of any reasonable relationship to its vault facility. In that connection, Mr. Clayton commented that in the examination of member banks, receipts covering securities in the custody of correspondent banks were rarely if ever questioned, and that if that were the case there should be no objection on the part of a Federal Reserve Bank to accepting receipts as representing securities pledged as collateral for an advance by a Federal Reserve Bank. Leach said that this matter had been of concern to his Bank for several years and had been brought up repeatedly, that he did not think there was any great risk involved in the acceptance of such receipts from selected banks, but that there were a number of other possible difficulties because if receipts were accepted from New York correspondent banks there would be a question of why they were not accepted from correspondent banks within the district and, if that were done, why they should not be accepted "from the bank across the street". It was his view that it would be better to accept receipts from all correspondent banks if no other satisfactory solution could be found, but he said that when the Federal Reserve Bank of New York established a quota system in accordance with which it undertook to accept the deposit of securities by New York banks for their correspondent banks, the problem was solved so far as the Fifth Federal Reserve District was concerned. As long as that arrangement continued, he believed few Government securities would be sold in the district to meet needs for reserve funds for short periods. Some of the other presidents indicated agreement with Mr. Leach's views. Sproul inquired how the question presented by the Board had arisen and Chairman Eccles stated that banks had written to the Board about it, that apparently member banks did not know of the Possibility of depositing securities with the Federal Reserve Bank of New York and that if the custody receipts of a correspondent bank could be pledged as collateral it would encourage member banks to borrow for short-term reserve needs rather than to sell the securities. la.. Davis asked if the letters received by the Board from member banks were sent to the Federal Reserve Banks in the respective districts for consideration and Chairman Eccles stated that they had not been and that the Board had felt that the acceptance of custody receipts was a service that might well be provided to member banks and that the Board had presented the matter to the Federal Reserve Banks to ascertain whether there was any objection to the adoption of the practice from the standpoint of the System as a whole. Yr. Clayton commented that he had been advised by a member bank in the San Francisco District that a branch of the Reserve Dank had been willing to accept, a trust receipt for a period of 15 days but that after that time the actual securities would have to be deposited. 1:r. Davis expressed the view that any question raised by a member bank on this matter could be disposed of readily by advising the bank of the arrangement for the deposit of securities at the Federal Reserve Bank of New York which was entirely satisfactory so far as member banks of the St. Louis Federal Reserve District were concerned. Mr. Earhart said that it would be appreciated if any questions presented by member banks of the San Francisco District were referred to his Bank, that the outstanding instructions of the Bank to its branches were that member banks may borrow on Government securities held in New York or, if necessary, on custody receipts from New York correspondent banks, but that he would not be willing to accept trust receipts from any and all correspondent member banks. He believed that each Federal Reserve Bank should have the opportunity of determining whether it should accept a receipt issued by a particular correspondent member bank and he saw no advantage in advertising the arrangement as any particular situation could be met satisfactorily when it arose. 29 In response to an inquiry from Chairman Eccles, Hr. Sproul stated that `it had been understood for several years that, in emergency situations, the Federal Reserve Bank of Nen-York would accept the deposit of securities held in New York as collateral for loans by a Federal Reserve Bank in another distric t to one of its member banks. In a discussion of the arrangement recently adopted under Thich securities may be deposited at the Federal eserve Bank of New York in the aggregate amount of 'kl.5 billion, it was stated that this arrangement was deemed adequate to meet anticipated needs of member banks in the various districts for the forseeable future. During a discussion, 1:r• McLarin referred to the circumstances under which the question of acceptance of custody receipts arose in the Atlanta District in 1945 and i.Tr. lhittemore mentioned a suggestion that had been made at his Bank that if the Board's proposal were adopted it might result in a greater centralization of securities in New York than was the case at the present time. In connection with Mr. McLarin's comment excerpts from the Board's letter to him under date of January 3, 1945, were read and Chairman Eccles discussed briefly the changes that had taken place since 1945 which suggested the need for a change in policy. :a.. Sproul stated that the question had been raised because of complaints of a few member banks and it would appear that the matter might not be an important one. Chairman Eccles responded that the Board had considered the matter from a standpoint of a service that might well be provided for member banks located outside of New York City. 1dr. Sproul commented that it was believed that essentially that service was being provided by the arrangement for the deposit of securities at the Federal Reserve Dank of New York. Chairman Eccles replied that that was the case to the extent that the member banks knew of the arrangement and that they should be advised of it so that when they purchased securities in New York they could leave them there and borrow on them whenever necessary in order to obtain reserve funds for short-term needs and not be forced to sell securities to get needed funds. Mr. Gilbert stat'gd that from a legal standpoint it is questionable whether notes secured by trust receipts covering Governm ent securities, instead of by the securities themselves, could be deposited with the Federal Reserve Agent as collateral for Federal Reserve notes, and pointed out that unless the procedure being advocated by the Board of Governors could be followed during extremely heavy borrowing periods, such as might develop later, as well as during light borrowing periods, such as at present, he doubted the advisability of inaugurating the procedure and bringing it to the attention of member banks generally. Yr. Sproul stated that it had been the thought of the presidents that provision of facilities for the wire transfe r of Government securities would tend to increase the holding of securities by banks in their own vaults, that facilities for tire transfer of bills and certificates had existed for some time with that result, and that the adoption of the same arrangement for bonds should reduce the need for holding securities in Now York and, therefore, the importance of the question of trust receipts as collateral security. After some further discussion, rr. Sproul also said that it appeared that the principal question raised by the discussion was whether trust receipts should be accepted from all correspondent member banks or only from selected banks, and that to do the former might raise difficulties which could not be easily disposed of once the arrangement had been put into effect. He suggested that, since the matter was not an urgent one, it be placed on the agenda for discussi on at a later meeting on the basis of a memorandum which would state the prob lem and the reasons why a change should or shou ld not be made. In this connection he expressed the opinion that the procedur e of the joint meetings of the Board and the presidents would be improved if, whenever an item was placed on the agen da of the Conference of Presidents at the request of the Board, it could be accompan ied by a memorandum covering the back ground of the topic. Chairman Eccles suggested that the Boar d review the matter in the light of the discussion at this meeting and submit a proposed policy statement to each of the Federal Reserve Banks and that afte r the comments of the Banks had been received the statement be revised and submitted to the Federal Reserve Banks for consideration. This suggestion was agre ed to. el° r ire'D AN FILEz SeLTION 1 FEF3 - 4 1948 Z P, 1948 Mr. Allan Sproul, Chairman, Presidents' Conference, Federal Reserve Bank of New Iork, Nee York 45, Nee York. Dear Mr. Sproul: For Approv4_, In its letter of November 25 1947_(.5 1000 eo the Preeidente 7 or all o7 the Fedeeal Reserve Banks, the Board expreseee the view that the Federal Resere Banks properly may accept custody receipts of re— sponsible city correspondent banks, ac well au thoee of tea Federal Re— serve Bank of Now York, for reasonaae periods where actual delivery of • securities as collateral for a loan is not convenient for the borrowing bank and that this practice may enable the Reserve lanSs to be of greater service to their member Apkinke. Me letter alse stated that if there were any question about this procedure, the 6card eould glati to discuss it with the ?residents at the time of the next Preeients' Conference. First of Mr— The matter was discussed at the seperate meeting of the Conference on Deceeber 8 at which time President Leach stated that ?real/dts / he would not favor the acceptance of custody receipts issued by a city Mr. SzYmOsak4 --675Frespowient bank for the reaoon that a Federal eserve ',sank could not Mr. Draper...... iry well accept custody receipts issued ey correspondent banks in New Mr. Evans City ane refuse to accept similar receipts issued by banks within Mr. Vardama own district and that to refuse to accept custody receipts issued by ....1.2Articular member bank in a Federal iss - ree Jank's 0-41 district cold Mr. Clayton.... _ to difficulty in bank relations. Some of the Fseeiente iJaeicated Mr. Thursto tnir concurrence in this view, while others:, tieeughe teet custody re— ese If you approv initial and ret te ceiets issued by responsible city correepondent senke should be accept— ' — able in some cireumstances. It wan the consensus that any Reserve .3,arlk Ir. Brennan ehichwishedto do so should ee free to accept tele custody receipts of re— IL city correspondent banks but t.let the practice of receiving " 1 such recelpte from correspondent banks should not be eecoursed. In view of the varyin opinions as to the extent te which euch receipts should be accepted by Federal Reserve anks, the Board will ape preciute it if you will have this matter placed on the agenla for the c.,next Presidents' Conference for discussion at the joint meetint of the ; Presidents ansi the Board. Very trul:/- yours, cc: Mr. Tre SRC/mg 1 REC TN FILES SECTION JAN 9 1948 , Dear Sirs This is to advise yo that the Prd of Governors concurs in the views of the :Presidents s expross d at their last Confererce that the maturity value of Treaslry dile should be considered as the loan value thereo \ It is expected that all Federal Reserve Banks will adopt this policy in the interest of Sy1 tem/i miformity. Ve // t‘ruly yours, / R,\Carpenter, Secretary. TO THE PRrElDFLTS OF ALL/FEDERAL RESER VE JJCsgme 1 1 ANKS ,- - Dettentser 17- 190 , Mr. Smead Mr. Sherman The following excerpt from the minutes of the joint asetimig of the Board and the Presidents of the Federal Reserve Banks held OR December 9, 1947, is quoted for your information: 23. Fuoctional expense reports. The Conference re— viwed the experience to date with respect to the prepara— tion of functional expense reports on Fort F. R. 634, The Conference recommends that such reports be submitted quar— terly rather than monthly as at present. The adoption of this recommendation would reduce the work at the Reserve Banks of preparing the reports and the work at the Board of compiling the material therein in conparative form. Monthly operations fluctuate so greatly that comparison of monthly figures at the different Reserve Banks gives a distorted view of operations. 'The members of the Board indicated that they would be willing to approve the above recommendations. " 44 / Loan value of Treasury bills. The Chairman of the "4. Conference reviewed with the presidents the Board's letter of December 5.2_1.947,,, to ht.: as president of the Federal Re— serve Bank of New York regarding the amount which the Re— serve Banks should loan again2t Treasury bills. The presi— dents recognize thLt inasmuch as Treasury bills are sold at a discount the Reserve Banks would be justified in establish— ing a loan value approximating the price at which the bills are sold. Nevertheless, a majority of the presidents believe that in view of past practices with respect to loans secured by Government securities and the possible inconvenience in— volved in 'raking an e:ception with respect to Treasury bills, the Reserve Banks should lend on TrwAsury bills the maturity value thereof. 'Chairman Eccles st%ted that the Board would not hEve any rea— son to disagree with the views expressed by a majority of the Presidents and that, since that was the view of the .s6jority, the Board would be willing to accept it as it felt the procedure followed at all of the Federal Reserve Banks in this connection should be uniform.' mSigbg , 01.64.. Ob. NW 0 IN FILES SECTION W JAN 2 8 1949 NEW BUSINESS Custody receipts for collateral securing loans to member banks Mr. Leach referred to' the concurrence of the presidents at the meeting of the Conference of October,3, 1947, (mins. p. 3) in the arrangement suggested by Mr. Sproul for the custody by the Fedeml Reserve Bank of New York of Government securities belonging to member banks in other districts in order that such securities might be used as collateral by the Reserve Bank of the district in which the member bank was located. He called attention to the Board's letter, S-1000, of November 25, 1947, stating that it appears to the Board that the Reserve Banks might properly accept custody receipts of responsible city corre— spondent banks, as well as those of the Federal Reserve Bank of New York, for reasonable periods where actual delivery of securities is not convenient for the borrowing bank. Mr. Leach stated that he did not favor the accertance of custody receipts issued by a city correspondent bank. He pointed out that a Reserve Bank could not very well accept custody receipts issued by correspondent banks in New York City and refuse to accept similar receipts issued by banks within its own district. To refuse to accept custody receipts issued by a particular member bank in its district, he said, could lead to difficulties in bank relations. Some of the presidents indicated their concurrence in this view. Others, however, thought that custody receipts issued by responsible city correspondent banks consensus that any 'should be acceptable in some circumstances. It was the , Reserve Bank which wishes to do so should be free to accept the custody receipts of responsible city correspondent banks but that the practice of rceiving such receipts from correspondent banks should not be encouraged. • Loan value of Treasury bills .11MWM111,11111=1... Mr. Sproul stated that the F'Aeral Reserve Bank of New York recently received an inquiry as to the loan value which it would be willing to assign to Treasury bills pledged by a member bank to secure advances by the Reserve Bank to it. He stated that hie bank had taken the position that, since Treasury bills (unlike other Government securities) are sold at a discount, the bills should have a loan value approximating the price at which they are sold and that at the present this value would be about 99-1/2. He read to the Conference a letter dated November 14, 1947, which he had written to the Board of Governors with respect to this matter and in which he suggested that the System policy be uniform in regard to the loan value of Treasury bills. He then read to the meeting the Board's reply of December 5, 1947, in which the Board stated that it saw no reason to differ with the conclusion that inasmuch as Treasury bills are sold at a discount the Reserve Banks should establish a loan value approximating the price at which they are sold. The presidents recognized that, inasmuch as Treasury bills are sold at a discount, the Reserve Banks would be justified in establishing a loan value approximating the nrice at which the bills are sold. Nevertheless, a majority of the presidents expressed the belief that, in view of past practices with respect to loans secured by Government securities and the possible inconvenience involved in making an exception with respect to Treasury bills, the Reserve Banks should lend on Treasury bills the maturity value thereof. It was unerst?,cd that this matter would be discussed with the Board at the joint meeting of the Board and the presidents. f. • I .,, / 1161)IN FILES SECTION It •••• a• e ........ascrtirg* • 4. Loan value of Treasury bills. The Chairman of the Conference reviewed with the presidents the Board's letter of December 5, 1947, to him as president of the Federal Reserve Bank lf New York regarding the amount which the Reserve Banks should loan against Treasury bills. The presidents recognize that inasmuch as Treasury bills are sold at a discount the Reserve Banks would be justified in establishing a loan value approximating the price at which the bills are sold. Nevertheless, a majority of the presidents believe that in view of past practices with respect to loans secured by Government securities and the possible inconvenience involved in making an exception with respect to Treasury bills, the Reserve Banks should lend on Treasury bills the maturity value thereof. Chairman Eccles stated that the Board would not have any reason to disagree with the views expressed by a majority of the presidents and that, since that was thc view of the majority, the Board would be willing to accept it as it felt the procedure followed at all of the Federal Reserve Banks in this connection should be uniform. Mr. Allan Sproul, President, Federal Feeerve Rank w New York, New York 45, le.w York. OEC - 5 1941 Dear Mr. Sproul: This refers to your letter of November 14, le)47, relating to the amount which the Feserve Banks shou ld loan against Treasury bills and requesting any views that the Board :pay wish to express iu connection with the matter. The Poerd sees no reason to differ with the conclusion which you have reached, that is, that inasmuch as Treasury bills are sold at a discount the Federal I-,eserve - enes should estaiish a loan f value epproximating the price at whic h they are sold. The first of the two questions ment ioned in your letter relats to the applicability of the provisions of section 3(e) of Regulation A which require that, in any case in which the amount of an advance made by a Federal Reserve Bank on a member bank's note secured by obligations of the United Stat es is less than the "face amount" of such obligations, the Reserve Bank shall include an exiA.anation of the facts and circumstances of the case in its loan schedule suemitted to the Poard. The language of the regulation is brond and coes not eistinguis! between interest-bearing , obliaticne and those which are sold at a discount. However, it is believed thet the underlying principles apply only to loans of lees than "face amount" as theet. tern is used in the case of interest -bearing obligations, i.e., the principal of the obligations. It would not appear, therefore, to conflict with these principl to construe the regulation as not rec!uirint ; explanetion of loans at ainst Trea sury hills in amounts are2eoximetint tee price at which the ',ills are , sole by the Treasury sin e /he eirference between the sale pric e nnd the amount payabl=i on maturity represent.) inteest. The Board beli eves het an Explanetion in thes e circumstances is unnecessary. Vo. Mr. Allan Sproul -2- The second ,luestion relates to the value at which Treasu ry bills should be accepted as collateral for Federal Reserve notes pursuant to the second paragraph of section 16 of the Federal Reserve Act. It appears, however, that thi. cAiestion is academ ic at this time since the Reserve Banks furnish excess collateral in such amounts as to maAe it immaterial whcther the Treasur- bills are accepted at the amount payable on maturity or at cost. Also, it is believ ed that this fuesti_n is not necessarily involved in the detem;nation of the amount which the ?eserve Banlr.s should loan agains t Treasury bills. It is understood that you have laced this subject on the atTenua for discussion at the next met:tine of the Presidents' Conference. If any of the Pre:idents have views different fro; those stated i above, it will be apdreciated if you will advise the Board accordilvly. Very truly ;ours, For Approval (SIGNED)S. R. CARPENTER First of Mr S. Mr. Szymczak. NOW R. Carpenter, Secretary. Mr. Draper Mr. Evans 17 . Mr. Vardaman Mr. Clayton :,;r. Thurston !I' you approve initiq and ret gr. Brennan ase to VhAttc, c (HA_ REC'D IN FILES SECTION • 41k0V 2 61947' BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM S-1000 WASHINGTON 25. D. C. ADDRESS OFFICIAL CORRESPONDENCE TO THE BOARD November 25, 1947. Dear Sir: Reference is made to the arrangement discussed at the Presidents' Conference in October under which the Federal Reserve Rank of New York will act, within certain limits, as custodian of Government securities pledged as collateral for loans made by the other Reserve Bunks to member banks in their respective districts. It has been the practice of at least one of the Reserve Banks to accept custody receipts issued by city correspondent banks in another district covering securities pledged as collateral for loans which the Reserve Bank makes to its member banks. Under this practice, the Reserve Bank receives a receipt from the city correspondent bank which states that such bank is holding specified securities in custody for the account of, and subject exclusively to the written order and direction of, the Reserve Bank. The Reserve Bank also enters into contracts with its member banks by which the Reserve Bank is relieved of any liability for the negligence of the custodian bank. It appears to the Board that the Reserve Banks may properly accept custody receipts of responsible city correspondent banks, as well as those of the Federal Reserve Bonk (,f New York, for reas,mable periods where actual delivery of securities is not convenient for the borrowing bank, and the Board believes that this practice may enable the Reserve Banks to be of greater service to their member banks. Should you have any question about this procedure, the Board will be glad to discuss it with you at the time of the next Presidents' Conference. ,ez rp3nter, Sec etary. / TO THE PRESIDENTS OF ALL FEDERAL RESERVE BANKS. 3/ oo REM IN rILE,A6LTION , DEC 3 i947 \TV 25 1947' Dear Sir: Reference is made to the arrangement discussed at the Presidents' Conference in October under which the Federal Reserve Bank of New York will act, within (tartan limits, as custodian of Government securi ties pledged as collateral for loans made by the other Reserve Banks to mambor banks in their respective districts. It has been the practice of at least one of the Reserve Banks to accept custody receipts issued by city correspondent banks in another district covering securities pledged as collateral for loans which the Reserve Beak makes to its member banks. Under this, practice, the Reserve Bank receives a receipt from the city correspondent bank whieh states that such bank is holding specified securities in custod y for the account of, end subject exclusively to the written order and direction or, the Reserve Bank. The Reserve Bank also eaters into contra cts with its member banks by which the Reserve Bank is relieved of may liability for the negligence of the custodian bank. For Apprrv• Pile of Mr. Kr. .}Linsam. Mr. Szyrneza iTr. Draper Mr. Evans Yr. Vardaman. Mr. Clayton r. It appears to the Board that the Reserve Bank* may properly accept custody receipts of responsible city correspondent banks, as well .asthose of the Federal Reserve Bank of New York, for reason able periods -Where actual delivery of securities is not convenient for the borrowing bank, and the Board believes that this practice may enable the Reserv e to be of greater service to their member banks. Should you have any question about this procedure, the Board -4411 be glad to discuss it with you at the time of the next Presid ents' -- conterenoe. Thurn.ton... yral approve r1 And return to r. Drerutan Very truly yours, I stiiNED) S. R. CARPENTER 3. L Carpenter , 8serotary TES ON NOV 25 1947 JCB:jbs 11 i /2;M TO TEE PRESIDENTS OF ALL FEDERAL RESERVE MEM [1 RE ' IN FILES SECTION .30ARD OF GOVERNORS EC 3 1947 OF THE FEDERAL RESERVE SYSTEM Office Correspondence To Board of Governors From Messrs Smead and Vest Date November 19, 1947. Subject: Use of Custody Receipts of Correspondent Banks in Making Reserve Bank Loans In accordance with a proposal discussed at the Presidents' Conference in October, the Federal Reserve Bank of New York has arranged to act, within certain limits, as custodian of Government securities pledged as collateral for loans made by other Reserve Banks to member banks in their respective districts. Under this arrangement, securities owned by a borrowing member bank and in the custody of its New York City correspondent are delivered to the Federal Reserve Bank of New York which holds them in safekeeping for the account of the Reserve Bank which is making the loan. It is now proposed that, in addition to the foregoing arrangement, the Reserve Banks accept custody receipts issued by any responsible city correspondent bank covering Government securities in its custody which are pledged by member banks as collateral for loans made by the Reserve Banks. The occasion for arrangements of this nature arises from the fact that large amounts of Government securities owned by member banks are held in custody by city correspondent banks and particul arly by banks in New York City which is the primary market for such securities. In some cases where member banks desire to borrow upon such securiti es, it may not be practicable to deliver them to a Reserve Bank. Hence, unless custody receipts are used, it is necessary for the member bank to borrow from a commercial bank in the city in which the securities are held or sell the securities. The present Federal Reserve Bank of New York arrangement to act as custodian for the other Reserve Banks grew out of a practice which arose during the war. The Federal Reserve Bank of New York undertook to act as custodian for Government securities pledged by member banks in other districts as collateral for war loan deposits and issued custody receipts to the other Reserve Banks. This practice, and also the use of receipts of city correspondent banks, was permitted by the Treasury Department. In some instances, Reserve Banks made loans with securities in the custody of the Federal Reserve Bank of New York as collateral. Objections to the practice developed, particularly because the securities tend to remain with the Federal Reserve Bank of New York after the occasion for their being so deposited has ended. As a result, the Federal Reserve Bank of New York took steps to obtain the withdrawal of the securities from its custody. The desirability of some such arrangem ent, however, led To: Board of Governors -2- to the plan which has now been put into effect under which the Federal Reserve Bank of New York will hold securities in an aggregate amount not exceeding $1,500,000,000, with each other Reserve Bank having a fixed quota and the responsibility for seeing that this privilege is not abused by particular member banks. The proposal that the Reserve Banks accept custody receipts of city correspondent banks in making loans to their member banks is in accord with a practice which has been followed by the Federal Reserve Bank of Atlanta and which was considered by the Board in January 1945. The Federal Reserve Bank of Atlanta accepts receipts issued by the New York City correspondents of their member banks which state that the New York City banks hold specified securities in custody for the Federal Reserve Bank of Atlanta and subject to exclusive control by it. The Federal Reserve Bank of Atlanta also enters into agreements with its member banks which relieve the Federal Reserve Bank of Atlanta from any liability for negligence on the part of the custodian bank. In a letter dated January 3, 1945, the Board advised the Federal Reserve Bank of Atlanta that it agreed that the Reserve Bank legally might accept the custody receipts in lieu of actual delivery of the securities and that the Board would not object to the Reserve Bank continuing this practice. It did state, however, without explanation, that it felt that the use of this practice should not be encouraged. The Federal Reserve Bank of Atlanta has continued the practice and we have been advised informally that it has been found satisfa ctory and a great convenience. As stated in the Board's letter to the Federal Reserve Bank of Atlanta, there is no legal objection to the use of custody receipt s of city correspondent banks. From a practical standpoint, such a receipt, of course, does not afford the same protection as actual possess ion of the securities by a Federal Reserve Bank. According to informal advice received from the Federal Reserve Bank of New York, experience has shown that where receipts are outstanding for a considerable period, complications arise because of retirement, exchanges, and sales of Governm ent securities and there is some danger that, in nandling large volumes of security transactions, correspondent banks may overlook the fact that receipt s are outstanding and release securities without proper authori ty. For this reason, it is understood that some of the Reserve Banks have not favored the use of such receipts. However there would appear ) to be no significant risk with respect to receipts which are issued by responsible banks and are outstanding only for relatively brief periods. If securities were improperly released, the custodian bank would be liable for its negligence and, of course, the borrowing bank would remain liable on its note. It may be argued that, since the Federal Reserve Bank of New York has arranged to act as custodian for the other Reserve Banks, there is no To: Board of Governors need to use custody receipts of correspondent banks. However, the amount of securities which the Federal Reserve Bank of New York is prepared to hold is limited; and, while it would appear to be adequate at present, there is no assurance that it will be in the future. Also, some New York City correspondent banks may object to transfers of securities to and from the Federal Reserve Bank of New York for this purpose. In addition, while the securities normally will be in New York City, they may be in the custody of correspondent banks in Chicago or possibly other cities. It has been suggested that the contemplated expansion of the telegraphic transfer of Government securities to apply to Government bonds, as well as short-term securities, will eliminate the need for the use of custody receipts. However, this will not provide an answer to the problem because it is proposed to authorize wire transfer of bonds only in connection with the sale of bonds and, accordingly, transfers of bonds for use as collateral would not be permitted. It is believed that the acceptance of custody receipts of correspondent banks may enable the Reserve Banks to be of greater service to their member banks and, if reasonable precautions are used, there appears to be no substantial reason why the Reserve Bank should not adopt this practice. Accordingly, there is attached hereto a proposed letter to all of the Federal Reserve Banks indicating the Board's approval of the practice. The letter also states that the Board would like to discuss this matter vith the Presidents at the next Presidents' Conference. Attachment ii 416C'D IN FILES SECTION ARD OF GOVERNORS OF THE DEC 3 1947 FEDERAL RESERVE SYSTEM Office Correspondence To Files From Mr. Baumann Date Subject: Use of Custody Py-ceilts of Con3pondent Bans in Making Reserve Ban' Loans ,- I telephoned Mr. H. T. Patterson, General Counsel, Federal Reserve Bank of Atlanta, on November 13, 1947, to obtain information concerning the use by his bank of custody receipts issued by city correspondent banks covering securities pledged as collateral for loans made to member banks. The custody receipt form currently used by the Reserve Bank is identical to that which was forwarded to the Board with Mr. Bryan's letter of January 17, 1945. There have been minor changes in phraseology in the form of contract between the Reserve Bank and its member bans, but none which any wise affect the substance of the contract. I asked Mr. Patterson how the Reserve Ban': was able to make loans under this procedure without the delay involved in the mailing of the receipts from New York to Atlanta. He stated that the loans were made on the same day on which member banks requested them by the Reserve Bank accepting telegraphic advice from the custodian banks that the receipts had been executed and :laced in the mail. He also stated that in some instances where telegraphic advice was not received until the next day the loans were in effect made retroactively with "analysis credit" being allowed as of the date the loan was requested and interest being charged from that date. Mr. Patterson stated_ that the Reserve Bank had receipts of correspondent banks to a considerable extent practice was considered a great convenience. On the day Mr. Patterson, the Reserve Bank had 12 loans outstanding receipts were being used. used custody and that this I talked with where such IEC'D IN FILE S6cTION th 6E-C-4,-8 47 „ /19FEDERAL RESERVE BANK REC'D III'.44.; $ ioN DEC 8 1 1947 ' OF NEW YORK 45 November 14, 1947. Board of Governor's of the Federal Reserve System, Washington 25, D. C. Sirs: Recently one of our New York City banks inquired as to whether or not we would loan them par against Treasury bills should. they find it necessary to borrow. After consideration it was concluded that inasmuch as Treasury bills are sold at a discount we should establish a loan value approximating the price at which they are sold, and that for the present that value should be 99-1/2. The bank making the inquiry was informed that we would give Treasury bills a loan value slightly less than the amount payable in respect of the bills on maturity. We refrained, however, from mentioning a specific figure, it being our opinion that System policy should be uniform in regard thereto. This matter poses two questions -- (1) the provision of section 3(e) of Regulation A requires that the Federal Reserve Banks include an explanation of the facts and circumstances in any case in which the amount of an advance made by it secured by direct obligations of the United States or obligations which are guaranteed both as to principal and interest by the United States, is less than the face amount of such obligations; and (2) paragraph 2 of section 16 of the Federal Reserve Act requires that any application for Federal Reserve notes shall be accompanied with a tender to the local Federal Reserve agent of collateral security in an amount equal to the sum of the Federal Reserve notes applied for and issued pursuant to the application. Treasury bills held in the System Account and pledged as collateral to Federal Reserve notes at par also come within the requirements of this paragraph. Inasmuch as there is a question of System policy involved, the questions should be discussed at an early meeting of the Presidents Conference. Meanwhile, if the Board wishes to express any views concerning the patter, it would be helpful. Yours faithfull VICTORY BUY UNITED !STATES WAR Allan roul, President. V5,115 BONDS STAMPS 011 doll \ a N'4 0 'IV. 0 (Yr II ONOV21 1947 it2xT IIl FILES SECTION firARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM Office Correspondence To Mr. Smfrad From ss?. : 3,„1. zi- Date November 10 1947 Mr. Clayton Subject: You will recall that, as the result of consideration by the Presidents at their Conference last October, the Federal Reserve Bank of New York has made arrangements to hold, as collateral for loans to their members by the other Federal Reserve Banks, U. S. securities delivered to the New York Fed. by city correspondent banks in New York City. While these arrangements are an improvement over the existing facilities, there is no valid reason why any Federal Reserve Bank should not accept a trust receipt of a responsible city correspondent for the same purpose. The Chainman and I both feel that this is a service that should be rendered by the System to member banks which will not only help popularize membership but will of course reduce the necessity for member banks to sell their Governments instead of making short-term loans against them. Therefore, will you and Mr. Vest prepare a memorandum on this subject for consideration by the Board at an early meeting. / "3.2 `/ 'S 3 7. 'eL P • • FEDERAL RESERVE BANK OF NEW YORK October (34 116 # 1 (WILMS SECTION OCT 30 1947 4 Board of Governors of the Federal Reserve System, Washington 251 D. C. Dear Sirs: At the recent Presidents Conference there was general agreement with my proposal that within certain limits this bank act for the other Federal Reserve Banks as custodian of United States Government securities to be pledged as collateral to loans made by such other Federal Reserve Banks to member banks in their respective districts. At the conclusion of the discussion of this subject I informed the other Presidents that I would write them formally upon my return to New York. In order that the Board's files may be complete, I am enclosing a copy of a letter addressed to the Federal Reserve Bank of Boston which is similar to those forwarded to the other Federal Reserve Banks except in respect of the amount of the maximum quota. There is also enclosed a copy of the memorandum used in our discussion, which among other things reflects the basis upon which the quotas were established. Yours faithfully, Allan SPoul, President. Enc. 40c.t k.;u11.) IN FiLS SECTION • • 0 October 17, 1947. M. Laurence F. Whittemore, President, Federal Reserve Bank of Boston, Boston, Massachusetts. Dear Laurence: You will remember that at the recent Presidents Conference there was general agreement with my proposal that, within certain limits, this bank act for the other Federal Reserve Banks as custodian of United States Government securities tc be pledged as collateral to loans made by such other Federal Reserve Banks to member banks in their respective districts. The plan was based on a formula which would permit an aggregate of not to exceed $1,500,000,000 of securities to be lodged with us by the other Federal Reserve Banks at any one time. A quota was provided for each Federal Reserve Bank based on the ratio which its capital bore to the combined capital of the Reserve Banks (exclusive of New York) as of June 4, 1947. Under the plan, and for the purpose stated, we will accept from you for safekeeping, subject to your order, up to 0_35,000,000 United States securities. It is anticipated that each Federal Reserve Bank will make use of this facility to meet special needs, and so as to avoid abuses which might result in the development of a situation in which a few member banks would more or less constantly use the entire quota. I hope that this service will be of benefit to your bank as well as to the member banks in your district. The actual working out of the program will develop with practice, and if extraordinary situations arise, of course, we shall have to consider them in the light of the then existing situation. Yours faithfully, Allen Sproul, President. AP:AS/HP • • 0 • • Augustf8;41 - 11 VI.LES SECTION OC SAFEKEEPING FOR OTHER FEDERAL RESERVE BANKS AND BR.A1'CHS 2-871947 As a result of our recent discussion regarding future policy with respect to safekeeping of Government securities for account of member banks in other districts, when pledged as collateral, we have experimented with the establishment of a auota for each Federal Reserve Bank based on the ratio which the individual capital of each Federal Reserve Bank bears as at June 4, 1947, to the combined capital of the Federal Reserve Banks, exclusive of New York. On the basis of the above ratios and using two denominators, .:1,000,000,000 and $1,500,000,000, the following table shows the amount of member bank owned U. S. Government obligations which each Federal Reserve Bank would be permitted to lodge with us under each maximum: Federal Reserve Bank (exclusive of New York) Boston Paid in (000 omitted) (a) $ 11,170 Ratio to Total (b) 9.00% 81,500 million 1,000 million (application of ratios in column (b) to above) (in millions) 90.00 135.00 Philadelphia 14,208 11.45 114.50 171.75 Cleveland 18,715 15.08 150.80 226.20 Richmond 8,070 6.50 65.00 97.50 Atlanta 7,303 5.88 58.80 88.20 Chicago 22,801 18.37 183.70 275.55 St. Louis 6,313 5.09 50.90 76.35 Minneapolis 4,208 3.39 33.90 50.85 Kansas City 6,383 5.14 51.40 77.10 Dallas 7,091 5.71 57.10 85.65 143.90 215.85 81,000.00 0_,500.00 San Francisco Total 17,860 $124,122 100.00 Ve have the vault space and personnel to handle up to 1,500,000,000 without difficulty-. Should this arrangement be acceptable to the other Federal Reserve Banks, it would then be up to them to make allocations to the member banks served by them so as not to exceed the maximum established by us under the formula for the respective Federal Reserve Banks. • • • It is possible that as in the case of the Federal Reserve Banks absorb— ing the transportation Charges on direct sendings of checks forwarded by air freight express, some of the large correspondent banks may accuse the System of unfair competition. They may maintain that the proposed procedure will result in U. S. Government securities now held in safekeeping by them being withdrawn and transferred to as; also, in the loss of service charges or compensating balances and possibly some loans. It is my opinion that none of these accusations would be justified, principally because the aggregate amount of U. S. Government securities which we would hold at any one time under the procedure would be small in comparison to the total held b' the members of the System. ($63,000,000,000 as at December 31, 1946). Furthermore, with the recent evidence of some stiffening of lending rates and a tightening of reserve positions, it appears unlikely that the banks in the large centers will be willing to compete with the System on any large scale as lenders to correspondent member banks so.long as our discount rate remains at 1%. ! CTINFILESSECTION 11. JAN .; 6 , Custody by New York Bank of securities belonging to member banks in other districts / /6 / Mr. Sproul referred to the discussion of the meeting of the Conference on June 4, 1947, of the custody by the Federal Reserve Bank of New York of U. S. Government securities belonging to member banks in other districts in order that such securities might be used as collateral for a loan by the Reserve Bank of the district in which the member bank MS located. (mins. p. 15) He stated that since then the New York Bank has reviewed the matter with a view to determine whether a plan could be devised to meet the legitimate needs of member banks in other districts and yet remain within the limits of physical tolerance of the New York Bank and the limits of general policy with respect to services performed for member banks. The New York Bank has experimented with the establishment of a quota which would permit each other Reserve Bank to lodge with the New York Bank a quantity of member bank-owned Government securities equal to that portion of 11500,000,000 that the individual capital of such Reserve Dank bears to the combined capital of the Reserve Banks exclusive of the Now York Bank. The vault apace and personnel at the New York Bank is adequate to handle such an aggregate amount. Should such a ouota arrangement be acceptable\ to the other Reserve Banks, Mr. Sproul said, it would be up to them to make allocations to the member banks served by them so as not to exceed the maximum established under the formula for the respective Reserve Banks. Ho than reviewed the maximum under tho formula for each Reserve Bank. In response to an inquiry, he indicated that in the case of an etergency the New York Bank would be prepared to give special consideration to a request to increase temporarily the quota of a particular Reserve Bank. He stated that it is assumed, however, that each Reserve Bank would avoid letting develop a situation in which a few member banks in its district would use up the entire quota for that district. ,The presidents indicated their concurrence in the arrangement suggested by Mr. Sproul; and he stateri that the New York Bank would write the other Reserve Banks with respect to this matter. / :7, 7 .T0N i 7 . 11.4..1 1 5 .. . ,,/ ,,,, „0.4......... March 5, 1946 . Wr.61r.ead Fr. C:irdenter Attched are excerpts fror the rinuten of the meeting of tf:e Boi!rd with the Preslcie:..ts on February 28, 1946, r31ating to (1) buildinc, facilities of Reserve JrAnks and bruncl:es, anti (2) non-merbe'r bail: loans on Governr.ent lecuv1tie3. Attachments l 15. Non-member bank loaas on Government securities, The Conference acain considered the advisability of discontinuin the orivilee;e of securing advances on Government obligations by non-member banks at the same rate as menber banks. After reviewin the present and prospective situation, the general consensus was that this privilege of non-mernber banks sho,ld be withdrawn. ChArman Eccles stated that the board agreed with the Presi dents on this matter and that the reasons for grantinf, the privil ege to non-member banks in 1929 no longer applied. It was understood that the 'board would approve action by the Federal Rese: -ve Banks to discontinue the rate of one per cent on advances to nonmember banks secured by direct obliations of the United states. ...11111.an • T2ICAL _1 Janusry 17, 194E. VT.. C. S. Young, President, Federal re.lsrve Bank of Chicago, ChicaRo 90, Illinois De.5 , Young: //d7 /e / For your inforlation, we are kmcioeing iritb a et- y of a lettor from Mr. Glenn It% Trumbo, 4 Treasurer, Chice.go Title and Tri:st Corpary, end a copy of OUT roply. Very truly yours, (Signed) Bray Hammond Bray Hammond, Assi stant Secretary. 1111c1o6ureG PIC:rye 1 A. L. Yates JAN 17 1946 Mt, Glenn ii6 Trumbo, Assistant Treasurer, Chicago Title & Trust Company, 69 West Washington Street, Chicago 2, Illinois. Dear Mr. Trusibos This refers to your letter of January 7, 1946 inquiring whether member banks may exohange Government obligations for money at the Federal Reserve Bank other than through the regular discount procedure. Member banks may borrow at their Federal Reserve Banks on their 90 -day promissory notes secured by direct obligations of the United States. This is covered by sections 2(b) and 3(e) of the Boardtc Regulation A, a copy of which is enclosed for your information. The rate of discount charged on such advances is 1 per sent per annum unless they are secured by obligations maturing or callable in one year or less, in which case the rate is one-half of 1 per cent. A member bank may also sell Treasury bills to a Federal Reserve Bank and retain, if it so desires, an option to repurchase them at the rate of discount, three-eighths of 1 per cent, at which they were sold. It may also deliver United States Government obligations to the Federal Reserve Bank with a request that they be sold in the open market. The proceeds of the such advances or sales are credited by the Federal Reserve Bank to the member bank's reserve account , and the member bank may, of course, make withdrawals from its reserve account by check or draft or in the form of cash. If you should desire more detailed information with respect to this matter, it is suggested that you may find it convenient to comunioate with the Federal Reserve Bank of Chicago . Very truly yours, 7/CAJIL (8fgrne4) Srs7 niviirnonel (9/ 0 -ccRrZoung, Chicago. K Enolos ELS:jbs 71-1cD F6 Bray ftimond, I Assistant Secretary. 7. '4- CONFIDENTIAL k'' ) St4- TIM , 4111VRD OF GOVERNORS C OF THE 2 71946 FEDERAL RESERVE SYSTEM Office Correspondence To Governor From Date Tune 13, 1945. Subject: BorrolUngs by banks for mr. mas0 end r-- At'0 7 \ raner .(6 tax credit rurnoses. V In accordance with your recuest, there is set forth below information available to us as to borrowings by member banks from Federal Reserve Banks for the purpose of obtaining credits on excess profits taxes, together with a brief statement as to the law and regulations of the Internal Revenue governing this matter. Instances of Borrowing On October 21, 1944, Mr. Gilbert, President of the Federal Reserve Bank of Dallas, called Governor Ransom and told him that the City National Bank of Houston had offered the Federal Reserve Bank its note for $30 million secured by short term Government obligations that it was buying in the open market. The borrowing was to be for a period of 31 days. Mr. Gilbert said that the bank had a capital and surplus of t2-1/2 million and deposits of t80 or t85 million. Upon inquiry, Mr. Gilbert found that the purpose of this transaction was to take advantage of tax savings. After being advised of the views of several members of the Board of Governors and after discussing the matter with the Reserve Bank's Executive Committee, he accordingly made known to the bank that the prompt liquidation of the advance, irrespective of maturity date, would be desirable. The note was paid 6 days before maturity. About the same time it was found that the Florida National Bank of Ocala, Florida, was borrowing 42 million. This borrowing was secured by United States Treasury 2 per cent bonds and was for a 90 day period. This bank has a capital account of t236,000 and deposits of $2,700,000. This borrowing was paid off some time prior to December 6, 1944,. although not due until Tanuary 22, 1945. One other case of whiCh we have a record is that of the Kanawha Valley Bank, Charleston, West Virginia. On February 19, 1945, the date of an examination, the bank was borrowing $5 million from the Reserve Bank. It had a capital account of $2,800,000 and deposits of $57,600,000. One of the reasons for the borrowing was that it was hoped to derive some benefit by increase in excess profits tax base. In its letter, S-843, of April 19, 1945, the Board suggested that the Federal Reserve Banks arrange to review any unusual application for discount facilities and ascertain before granting the discount whether the reasons for such application are consistent with the FOR TnT,TIS Margaret E, R7uhe. -2- proper needs of the bank for replenishing reserves. The Board's letter did not call for a reply but three Banks, New York, Philadelphia and Dallas, have aclmowledged the Board's letter. In doing so New York stated they had been cognizant of the possibility of such borrowings for some time and accordingly had been watching the borrowings of member banks very closely. Philadelphia states that they find no bank in the so-called "continuous borrowing" group and only ten that have borrowings more than forty days since the first of the year. The Bank does not believe that any of these banks borrowed for the purpose of setting up an indebtedness to increase the excess profits credit. Yr. Gilbert said only two cases of the kind referred to in the Board's letter have come to his attention, the one referred to above and the other where a smaller bank wished to borrow for the purpose of increasing its borrowed capital. In this case the bank was advised that borrowing for such purpose would not be a proper use of Federal Reserve credit and the Federal has heard nothing further from it since. We, of course, cannot tell definitely from the schedules received from Federal Reserve Banks whether any banks have borrowed for tax savings purposes as the reason for the borrowing is not shown. The case of the First National Bank of New 'York, however, seems noteworthy. According to our discount schedules, the daily average borrowings of the bank by months during 1945 have been as follows: January February March April May June 1 to 7 $34.5 million 44.1 " 59.0 61.9 45.6 69.3 The bank also borrowed substantial amounts in 1944. Tax Law and Regulations The general purpose of the excess profits tax is to recover back into the Treasury the excess corporate earnings attributable either directly or indirectly to the great expenditures which the Government is making in connection with the war effort. Since it is difficult to formulate a satisfactory statutory definition of earnings attributable to the war effort, the approach taken in the law is to define normal irofits and then treat all profits in excess thereof as attributable to the war. FOR, nurs P`I'r Margaret E, The statute accordingly begins by taking ordinary net income (gross income less business expenses) and deducting certain items (such as recoveries for bad debts, long-term capital gains, dividends from other corporations, etc.) which, because of their inherent nature, should not be subject to the excess profits tax. Next, there is deducted a "specific exemption" of '410,000 (to which every corporation is entitled), and, finally, there is deducted the "excess profits credit". There are two methods of calculating the excess profits credit, and the taxpayer may use the one which is most advantageous to him: The "average earnings" method determines normal profits by reference to the average earnings of the taxpayer during the "base period" 1936-1939 inclusive. The other method is known as the "invested capital" method. Under it, the taxpayer is entitled to a credit of a certain percentage (e.g., 8 per cent of the first 45,000,000) of capital, which, for the purposes of this calculation, includes (1) the money and property paid into the corporation since its organization, (2) accumulated earnings and profits and (3), 50 per cent of "borrowed capital". Borrowed capital is defined in section 719 of the Internal Revenue Code as "The amount of the outstanding indebtedness (not including interest) of the taxpayer Which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage, or deed of trust" plus certain other items not applicable to banks. Accordingly, there seems to be no reason to doubt that a note given by a meaber bank to its Federal Reserve Bank collateraled by Government securities purchased by the member bank would qualify as a "note" within the meaning of this provision. The Regulations of the Bureau of Internal Revenue (Reg. 112, sec. 35.719-1) further state: "In order for any indebtedness to be included in borrowed capital it must be bona fide. It must be one incurred for business reasons and not merely to increase the excess profits credit." Informal advice from the Internal Revenue Bureau is to the effect that the question whether the indebtedness is "bona fide" and incurred "for business reasons" within the meaning of this provision of the Regulations is one as to which no general rule can be laid down. The question depends on the facts and circumstances of each particular case. If the indebtedness is reasonable in amount in relation to the ' [ FOR ntiEs Marg.aret E. li7uber . ... -4- size of the borrower and there is likelihood of prompt repayment, it will probably be permitted to be included in borrowed capital, but if the borrowing is out of proportion to the size of the borrower or is not germane to the corporate business, it will not be permitted as borrowed capital. It must be an indebtedness incurred for business easons and not merely to increase the excess profits credit. We are advised that inquiries have been made of the Inernal Revenue on questions of this kind in connection with the war bond drives, where the borrowing was for the purpose of purchasing Government securities. The Bureau, in answering these inquiries, has had in mind that they did not wish to discourage the sale of bonds and on the other hand that they could not recognize as borrowed capital any indebtedness which was incurred merely for the purpose of avoiding tax. Accordingly the question liether a borrowing by a member bank from a Federal Reserve Bank would in any particular case give rise to a credit on the excess profits tax of such bank is one which, under the practice of the Internal Revenue Bureau, would be determined according to the circumstances of the case and in particular as to whether the facts indicated that the borrowing was a bona fide one and incurred for business reasons and not merely for the purpose of obtaining an excess profits credit. FOR rims WItrgaret E. June 13, 1945. Gov. Draper: We will be glad to discuss this with at your convenience. you E.L.S. G.V. r FOrt 777,11S Margret E, Firmber • CHICAGO TITLE & TRUST COMPANY ' cr -c t 69 W. WASHINGTON ST. TELEPHONE DEARBORN 7700• CHICAGO 2, ILLINOIS "N . " TRUST DIVISION i4 AN j January 7, l94P , Mr. Bray S. Hammond, Division of Correspondence, Federal Reserve System, Washington, D. C. Gentlemen: The question has arisen in one of our meetings as to whether the Banking Act of 1933 or some subsequent Act gave members of the Federal Reserve System the right to deliver to the Federal Reserve Bank direct obligations to the U. S. Treasury and receive therefor an equal principal amount of cash. In other wor3sdoes there now exist or has there ever existed any provision by which the Federal Reserve Bank could make advances to member banks on the securities of Government obligations other than through the regular discount procedure: It is my own impression that this question has arisen from a misinterpretation of Regulation A of the Banking Act of We should appreciate your advising us as to whether 1937. any regulation exists whereby member banks can exchange government obligations for money at the Federal Reserve Bank other than through this discount provision. Ver truly yours, C%4 GMT:cb FORM n tow 12-43 BI-. Glenn M.vTrumbo, Assistant Treasurer. 4.• 4-`4(4 ' 211243, 000"To1r5a 000'T56'3I 000409'IT 000l000lc 000'Gz'S 000'oo6'ci 000goct 000'6L'oc 000'ooe'9 000839'63 000to99' 11 000%8VEI 000g ag/..6 000'TL'ecS 000' 1190'8 000'966'c3c 000d eLCL3000'00.'099'a 000'35T1cc913 000'6/.6%6G'T 000'000"T ODOM 0.110 IP.ma 010 MOW. .011•• Meow 111•11.110 ••• NI falai* Woo ••••• ••• MO aeolme4das jø pue 4v JuTpuv;s4no 4unamy aegme4des 2uTanp seouvApv soxa aegme4des 2uTanp pTvd aegme4des 2uTanp peouve.pv 4sn2nv Jo pue 4v 2uTpuv4s4no 4unamv 000'17L5 i“ ( 000'.ce9'60e 000'009 000%30'oi 000looeaL 000'oa'L 00°160 000'000'33 000'gL6'iST 000'00c 000'00TLI 000'000'I 000looL'ec3 000'009'22 000'og)'03 00060M 000'ooVa 000'000lIc 00060S6‘6 000"0063 000'ooLgoii 000%ze9c 000tooeiCi? 000`006'693"1 000'06`Loil$ MOMS ••• am. 000'000'I 000'Lot'c 000'008 000'OcT 000'oa% o00'00“ MP O. 413 I WI 413 43Ta4sTG uT eaegmesis saT4T0 gouvaaled uI geI4TO 1 g16. Jegmegdos 2uTanp peoutaLpy q:e o0olailc9ea 000lc63'69L'a 000'69/1c3 000'000'c 000'ao'68 00066LOLC 000'a6 oLT ( ooe6Le'L6a 000"ogi'317 meatra 000'09/1663 000'0ee'87 0 000%091-107'T 000'596'9/V,; 000gi-Wic, 000'003 000'66tria 000'o06 (cci 000'OgrcTc 000'00033 000'6T3'62, 000#099itic.a owaisca 000 65eg0t14'T ( 000100 636TV 51761 4s11.*Iv 2uTanp peouvApv Tv4oI I134e1 4traellaa uI teq-61 oosTouvad uvs svirea .44T0 svsuvx sTiodveuuTw sTnol m4s avoTtio InullT4V puoutopi puvIeAeT0 vpidiepviTlid 31.1o.x. mem uo4sua CD (7D Ca zip QA.a0 Ivaeped (IMAMS J1IRAMHEA0!) - SMNIAI Hauval ol sapavAuv 9t76[ 2 7, 100 gomcac VITA If Eirrar June 22,1945 Mr. Pollard Mr. Xeniledy Some member banks, particularly in central reserve and reserve cities, have borrowed from the Federal Reserve Banks between drives when there has been a drain on bank reserves due to the shift in deposit s from reserve-exempt war loan accounts to accounts of individuals and businesses. The borrowings reach a peak just prior to a drive and are paid off during the drive as banks get reserve funds through the shift of deposits to war loan accounts. Member bank borrowim7s reached a peak of 900 million dollars on June 6; by June 20 this figure had been reduced to 300 million dollars. As you know, banks have been buying large amounts of Government securities prior to and during drives as nonbank investors adjust their positions in order to subscribe in the drives. While from an over-al l point of view the discounts and advances by the Federal Reserve hanks have provided ps.rt of the reserves necessary to cover bank purchases of Government securities, the individual bank that borrows generally does so not in order to buy Governments, but rather to keep from selling higher yielding Governments to meet drains on reserve funds. Part of the borrowings have been by New York City banks that did not have sufficient Treasury bills to meet large deposits shifts and preferred to borrow as a temporary expedient rather than to sell higher yielding uovernments. I agree with your friend that banks should not borrow to buy Government securities for permanent investment. But I see no objecti on to temporary borrowings to meet deposit fluctuations. As a matter of fact, borrowing provides a flexible and altogether satisfactory method of adjusting for fluctuations in deposits and is to be preferred over sales of Government securities (other than bills which have a special feature in the buying rate.) If a bank continues to lose deposits, it should look to a more permanent solution of its problem than borrowi ng and should adjust its holdings of Governments. 1 ..........._ _... _._. . . _ B.0 .i.z, .'.; . 1:.. i-iiS D. M. K.C11710,''' / RE,C'D 4 -.-Borrowing by Banks to Increase Excess Profits FILES SECTION 'F 1514 ax Bose The Conference discussed the question of member banks borrowing on Government securities, as collateral, for purposes of increasing "borrowed capital" to lessen or avoid excess prof taxes. In view of existing policy wren respect to _Deane ee Government securities, and in view of the impossibility in most cases of determination by the Reserve Banks whether such borrowing is for business purposes, within the meaning of the income tax law, the Conference was of the opinion that this is primarily and largely a matter for the Bureau of Internal Revenue, The Presidents desire to discuss this matter and this opinion with the Board of Governors, in the light of the Board's letter S-843, dated April 19, 1945. kt its meeting in February, the Conference considered this subject and the general consensus was that the practice of using Reserve credit by a bank for purposes of increasing excess profits tax base was improper, and that supervisory authorities should discourage this practice when it came to their attention. This, of course, is still the view of the Conference. There was a considerable general discussion of the practicability of determining in each case whether the purpose was to increase the tax base or some other purpose. The discussion touched upon a number of points, including the following: (1) Cases of banks thet were simultaneously buying Governments and borrowing when the circumstances would indicate that the purpose was not merely to make a profit by reason of the difference between the discount rate and the re to borne by the Governments, but also to increase the excess profits tax base; (2) Whether the preferential rate based upon Government securities maturing within one year should be eliminated or raised; (3) The Treasury financing program and the statement of policy announced by the Board of Governors in September 1939 in regard to lending on Government securities; (4) The desirability of obtaining a ruling from the Treasury as to whether the amount of such borrowing will be allowed in computing the tax base; and (5) the provision incorporated in paragraph 8 of section 4 of the Federal Reserve Act by the Banking Act of 1933, which expressly requires that each Federal Reserve Bank shall keep itself informed of the general character and amount of the loans and investments of its member banks, with-e view to ascertaining whether undue use is being made of bank credit for the speculative carrying of or trading in securities, real estate, or commodities, or for any other purpose inconsistent with the maintenance of sound credit conditions; and in determining whether to grant or refuse advances, rediscounts, or other credit accommodations the Federal Reserve Bank shall give consideration to such information. There were varying opinions among the Presidents as to the feasibility of determining in all cases when member banks were borrowing for the purpose of reducing their excess profits taxes. Mr. McKee called attention to an actual case which had developed in one of the Federal Reserve Districts, where the purpose had been entirely clear, and this was discussed. There seemed to be no difference of opinion that borrowing of that kind should be stopped. Mr. Young referred to the fact that the form of application for advances used at the Chicago Bank celled for information as to the purpose of the borrowing. It was agreed that if flagrant cases should ,develop, the Federal Reserve Banks should not permit such borrowing and, also, \ that an attempt should be made to get a ruling from the Treasury. In connection, the suggestion was mode that if the Treasury would select one or the more clear cases and announce a ruling, the whole problem would be disposed of. Chairman Day raised the question whether the Board would approve at this time a raise in the discount rate, but Chairman Eccles thought that such action should be deferred until the matter had been discussed with the Treasury, because of the close relationship between such action and the Government financing program. It was understood that thc Board, at the earliest opportune time, would takc up with the Treasury both the question cf r ruling by the Treasury on borrowings for the purpose of raising the excess profits tax base and the question of eliminating or raising the preferential discount rate. In connection with the use of the borrowing facilities of the Federal Reserve Banks in order to reduce the excess profits tax, Chairman Eccles said that he was concerned about the vulnerability of banks when there develops in the public mind a knowledge of the increasing earnings of the banking system and a feeling that something should be done about it which might, among other things, result in special taxation on the banks. Mr. Davis felt that the fact that the Board and the Federal Reserve Banks had carried on a drive for the purpose of getting banks into a more fully invested position should not be overlooked. Chairman Eccles, however, took the position that the question under consideration related to cases where investment was not the purpose but rather a temporary use of Government securities as a base for borrowing from the Federal Reserve Banks to evade tax obligations, which would not be a proper use of Federal Reserve credit. Mr. Gilbert said that he thought that the Federal Reserve Banks had a distinct responsibility in cases of the kind which had arisen in his district, and Mr. Davis said that he felt that all of the Presidents would take the some position as that which had been taken by Mr. Gilbert. Mr. Young described a case which had come to his attention, in which the application had been disapproved, and agreed with Mr. Gilbert. There appeared to be no disagreement on the part of any of the Presidents. 6lc r 1 ) / /vc,/-) (-7/(f/ • niits FILES 1 , BMW, 11945 / A .1 BORROWING BY BANKS TO INCREASE EXCESS PROFITS TAX BASE I Mr. Davis discussed the problem of member banks borrowing on Governnent securities as collateral for purposes of increasing "borrow ed capital" to lessen or avoid excess profits taxes. He raised a questio n as to who should pass on whether the borrowing is for business purpose s within the meaning of the income tax law. As he saw it, there exists an indistinguishable lino between business purpose and tax evasion, and he would like to see the matter handled through the Bureau of Internal Revenue instead of trying to handle it through the Federal Reserve Banks. He wondered how the Conference could draw this line. Mr. Sproul said that to draw such a line of distinction is extremely difficult, and referred to the fact that in the System statement of December 8, 1941 it was formally announced that the Reserve Banks stood ready to lend to all members and non-members on Government securities. We thus have a commitmcnt, but obviously if a bank is borrowing beyond its current needs, he thought it would be appropriate to question such a bank since such borrowing may run counter to the anti-inflationary objectives of the System. Mr. McLarin observed that so long as Government securities are offered as collateral his Bank does not question the borrower. The sense of the Conference was that, in view of existing policy with rospect to loans on Government securities and in view of the impossibilities in most cases of detennination by the Reserve Banks whether such borrowing is for business purposes, within the meaning of the income tax law, this question is primarily and largely a matter for the Bureau of Internal Revenue. It was also agreed that this subject, as well as the opinion of the Conference, should be discussed with the Board of Governors in the light of the Board's letter S-843, dated April 19, 1945. At its mooting in February last, the Conference considered this subject and the general consensus was that the practice of using Reserve credit by a bank for purposes of increasing the excess profits tax base was improper, and that supervisory authorities should discourage this practice when it came to their attention. This continued to be the view of the Confere nce. 1 C ONF I D I I t I £ I. WCT Tv 171, 4 MTiuj AR 12 1941 /Jr 8 On October 21, 1914 Mr. Gilbert, President of the Federal Reserve Bank of Dallas, called Governor Ransom and told him that the City National Bank of Houston had offered the Federal Reserve Bank its note for $30 million scoured by short term Government obligations that it IRA buying in the open market. The borrowing was to be for a period of 31 days. Mr. Gilbert said that the bank had a oapital and surplus of $2-1/2 million and deposits of $80 or $65 million. Upon inquiry, Mr. Gilbert found that the purpose of this transaction was to take advantage of tax savings. After being advised of the views of several members of the Board of Governors and after discussing the matter with the Reserve Bank's Executive Committee, he accordingly made known to the bank that the prompt liquidation of the advance, irrespective of maturity date, would be desirable. The note was paid 6 days befOre maturity. About the same time it was found that the Florida National Bank of Ocala, Florida, was borrowing $2 million. This borrowing was scoured by United States Treasury 2 per cent bonds and was for a 90 day period. This bank has a capital aocount of $236,000 and deposits of $2,700,000. This borrowing vas paid off some time prior to December 6, 1944, although not due until January 22, 1945. One other case of which we have a record is that of the Kanawha Valley Bank, Charleston, West Virginia. On February 19, 1945, the date of an examination, the bank was borrowing $5 million from the Reserve Dank. it had a capital account of $2,600,000 and deposits of $57,600,000. One of the reasons for the borrowing was that it was hoped to derive some benefit by increase in excess profits tax base. n 1.. a (.,, • 2 Ma its letter, 5-343s of April 19, 1945, the Board suggested that the Federal Reserve Banks arrange to review any unusual apnli cation for discount facilities and ascertain before granting the discount whether the reasons for such application are consistent with the proper needs of the bank for replenishing reserves. The Board's letter did not sail for a reply but three Bank*, New York, Philadelph ia and Dallas, have acknowledged the Board's letter. In doing so New York stated they had been cognizant of the possibility of such borro wings for some time and accordingly had been watching the borrowings of member banks very closely. Philadelphia states that they find no bank in the so-called "continuous borrowing" group ard only ten that have borrowings more than forty days sinoe the first of the year. The Bank does not believe that any of these banks borrowed for the purpose of setting up an indebtedness to increase the excess profits credit. Mr. Gilbert said only two eases of the kind referred to in the Board's letter have come to his attentions the one referred to above and the other where a smaller bank wished to borrow for the purpose of increasing its borrowed oapital. In this case the bank was advised that borrowing for such purpose would not be a proper use of Federal Reserve credit and the Federal has heard nothing further from it since. We, of course, cannot tell definitely from the schedules received from Federal Reserve Banks whether any banks have borrowed for tax savings purposes as the reason for the borro wing is not shown. The ease of the First National Bank of New York, however, seems noteworthy. According to our disoount sched ules, the daily average borrowings of the bank by months during 1945 have been as follows: — 3January February Maroh April Mai JUne / to 7 t34..5 million " 44.1 M 59.0 " 61.9 145.6 n The bank also borrowed substantial amounts in 19141i. ELS:jbe 643-45 CONFIDENTIAL £Att Jwtt's 1TILN'1 4 1946" , de/ June 13, 1945. 1;overnor Te-aper Borrowings by bans for 1.1r. Smead end Kr. Vest \'tax credit purposes. Carded In accordance with 7,011T re euest, there is Pet forth bolo. information F..vailable to us as to borrowings b 7-tember banks from Federal Reserve Banks for the purpose of obtaining credits on excess profits taxes, together with a brief statement as to the lew and regalationB of the Internal levenue ioverntng this matter. Instances of Dorrowin6 On October 21, 1944, ir. Gilbert, President of the Federal Reserve rank of Dallas, called Governor hansom and told him that the City National Bank of Houston had offered the Federal Reserve Bank its note :or $30 million secured by short term Government obligat ions that it was bujing in the open market. The borrowing was to be for a period of 31 days. kr. Gilbert said that the bank had a capital and surplus of 2-1/2 million and deposits of ,TA30 or :7- 85 million. Upon . inquiry, Mr. Gilbert found. that the purpose of this transaction was to take advanta5:e of tax savings. After being advised of the views of several menbers of the Board of Governors and after discussing the tatter with the Reserve Bank's Ixecutive Committee, he accordi ngly made known to the bank that tie prompt liquidetioe of the advance , _irreepective of maturity date, would be desirable. The note was paid 6 daes before maturity. •About the same time it was found that tee Florida Yetional ' ,.ank of Ocala, Florida, was borrowing T1 million. This borrowi ng was secured by United States rereaeure 2 per cent bonds end .as for a 90 dae period. This bank has a capital account of 236,000 and deposits of *2,700,000. This borrowine was paic: off some time prior to recember 6, 1944, althouah not due until Ianuare 22, 1945. One other ceoe of which ee have a record ie that of the Kanawha Valley Bane, Charleston, est Virginia. Cn Februar y 19, 1945, the:ate of an examination, the bank was borrowing ;-5 million from . the Reserve Bank. It had a capital account of *2,300, 000 and deposits of ':57,600,000. one of the reasons for the borrowing was that it was hoped to derive some benefit be increase in excess profits tax base. In its letter, b.-843, of April 19, 1945 3 the Eoard suggested that the Federal Reserve nenks arrenec to review any unusual applica tion for discount facilities and ascertain before :„,ranting the 1.scount whether the reasons for such application arc censietent with the FOR rams lisrpret E. fisuber e proper noede of the bank for replenishing reserves. The . 6oard's lettf-r did not cell for a reple but three "3anks, New York, Philadelphia and f, allas, have ac_nowledged the Loard's letter. In doing so New ork steted they had been cognizant of the possibility of such borrowi ngs for some time and accordingly had been watchine the borrowings of member banks very closely. Philadelphia states that they find no bank in the eo-called "continuous borrowing" ereup and only ten that have horrowinRe more than forty daee since the first of tbe 'ear. The 7Ank does not believe that any of these benks borrowed for the purpose of setting up an indebtedness to increase the excese profits credit, Gilbert said only two cases of the kind referred to in the hoard's letter have come to hie attention, the one referred to above end the other where a smaller bank %Jailed to borrow for the purpose of increasing its borrowed capital. In this; case the bank was advised that borrowing for such purpose would not be a proper use of Federal heserve credit erd the Federal has beard nothing further from it since. We, of ceurse, cannot tell deftnitele from the schedules received from Federal Reserve 13anks whether any banks have borrowed for tax savings purposes as the reason for the borrowir i not shown. The case of the First National Eank of New 'ork, however, seems noteworthy. According to our eiscount schedules, the eaile average borrowings of the bank b • months during 1945 have been as follows : January February March April June 1 to 7 t34.5 44.1 59.0 61.9 45.6 69.3 The bank also borrowed substertial amounts in 1944. Tax Law and Regulations The general pureose of the excess profits .ax is to recover back into tne Treasury the excess corporate earnings ettribute!le either directly or indirectly to the ereat expenditures which tLe Governm ent is making in connection with the war effort. Since it is difficu lt to formulate a satisfsetory statutor definition of earnines attribu teble to the ear effort, tjte approach taken in the law is to define normal erofits and teen treat all profits in exceee thereof as attributable to the war. r fort FILM kw, are L. Risuloat ntatute accordinely begins by takinc ordinary net income (gross income lesa busineao expense) anti deducting certain items dividends (such as recoveries for had debts, long-term capital from other corporations, etc.) which, because of their inherent nature, nhould not be subject to the exceas profits tax. Next, there is deducted a "specific exemption" of 10,000 (to which awry corpooation is entitled), an, finally, there is deducted the "excess profits credit". There aro two methoae of ca1culatin4 the exceer profits creCdt, and the taxpaer may LWe the one which ir most advantageous to him: The "average earnings" method determines normal profits by reference to the average earnings of the taxpayer 6urine the "base vriod" 1936-1939 inclusive. The other method is known es the "invented ca7ita1" method. Under it, the taxpayer in entitled to a credit of & certein percentage (e.g., 8 per cent of the first 0,000,000) of capital, which, for the pur,t.oses of this calculation, includen (1) the money and propertt paid into the corporation since itn organization, (2) accumulated earninFs and profits and (7:), 50 par cent of "borrowed capital". Eorrowed capital is defined in section 719 of the Internal evenue Code as "The amount of tke outstanding inCettedneas (not including interest) of toe taxpayer Which is evidenced bt a bond, note, bill of exchange, debenture, certificate of indebtedness, .ortgage, or deed of trust" plus certain otter items Lot applicable to banks. Act,iven. by a , cordingly, there acorns to be no reason to doubt that a rote : wember bank to its Federal Lecerve ank collateraled ba Government securities purchased by the member bank would civalify as a "note" within the matting of this provision. The Laulationa of the Zrureau of Internal Eevenue (Reg. 112, oec. 35.719-1) further state: "In order for any indebtedness to be :ncluded it borrowed capital it must be bone fide. It must be one incurred for businec. rces:ms an not merely to increeee the excess profits credit." Informal advice from the Internal i.--,venue 'tuleau lc to the effect that the cuestion whether the indebtedness is "hona fide" and incurred "for businesa reasona' within the meaning of this provision of the ilegulations is one as to which no general rule can be laid down. The .luestion depends on the facts and circuaistances of each particular , cane. If the indebtednesa is reasonable in amount in relation to the C l'Oit iii...wit3 \ *aft* F., Hole \-: aiiftwahas size of the borrower and there is likelihood of promipt repayment, it will prcbal-de be permitted to be 1r:eluded in borrowed. caeital, but if the 'r,orrowing le out of proportion to the Size of the borrower or is not gemane to the corporate business, it will not be pereitted as borrowed capital. It must be an indebtedness incurred for husineee ecesers and riot merely to increaee the excess profits credit. We are advieed that inquiries have been made of the internal Revenue on queetions of this kind in connection with the ear bond drives, where the borrowing wae for the i.erpose of purchasing Government eecurities. Tee 3ureau, in snewerine these ineuiries, has had in mind that they did not wish to discourage the Bele of bonds and on the other hand that t1::ey coul not recognize as borrowed capital any indebtedness whic wae incurred merely for the purpose of avoiding tax. Accordingly the ;zuention eliether e borrowing be a member bank from a Federal leserve Lank would in any particular case give rise to a credit on the excess 1:Tofits tax of such bank is one which, under the practice of the Internal Revenue reireau, would be determined according to the circumstances of the case end in perticular as to whether the facts indicated that the borrowing was a Lana fide one eAnci incurred for business reasons end not merely fer tee gurpos of obtaining en excess profits credit. ELS):lirn GP,V) 1 1 , 1 FEDERAL RESERVE BANK OF NEW YORK April 27, 1916. Board of Governors of the Federal heserve System, Washington 25, D. C. Dear Sirs: This will acknowledge your letter of April 19, 1945, in which you suggested that we review any unusual application for discount and ascertain before granting the accommodation that the reasons for such application are consistent with the proper needs of the bank, and that the borrowing is not being effected for the purpose of avoiding excess Profits taxes. We have been cognizant of the possibility of this happening for some time, and accordingly have been watching the borrowings of our member banks very closely. Very truly yours, A. Phelan, Vice President. VICTORY BUY UNITED STATES f?AR BONDS f i 4X.OT"A17, s / I ntik . 41 FEDERAL REORVE BANK OF' DALLAS / ! :VY , DALLAS 13, TEXAS 1 , April 26, 1945 Mr. Chester Morrill, Secretary Board of Governors of the Federal Reserve System Washington, D. C. Dear Chester: I have read with much interest the Board's letter, S-843i referring to the inclination of some member banks to borrow- from their Federal Reserve banks against Government securities under conditions which might raise some question as to the propriety of such borrowings. Only two cases of the kind referred to in the Board's letter have come to our attention, one with which you are already familiar, and the other where a smaller bank wished to borrow for the purpose of increasing its "borrowed capital." In the latter case, the bank was advised that borrowing for the purpose it had in mind would not be a proper use of Federal Reserve credit and we have heard nothing further from it since. I think the Board's letter is very timely because of the possibility that the practice of borrowing for such purpose might spread. Sincerely yours, FOPVICTORY MP/ R. R. Pres ert e t UNITED STATES WAR I sTAN'iDps A VOS t* tils° APR 28 1945 "' 4 ,4 FEDERAL RESERVE BANK OF PHI LAD E LPH IA OFFICE OF THE PRESIDENT April 25, 1945 Board of Governors of the Federal Reserve System Washington 25, D. C. Dear Sirs: Upon receipt of your letter of April 19, 1945, (ip77843Y\, we reviewed the records of member banks' borrowings with us since January 1, 1945. We find no bank in the so-called "continuous borrowing" group and only ten that have borrowings more than forty days since the first of the year. We do not believe any of these bnnks borrowed for the purpose of setting up indebtedness to increase the excess profits credit. While it is not specific proof, none of these banks that borrowed had excess reserves other than a reasonable amount, indicating, at least on the face of it, that the loan was necessary to restore reserves. A further checking failed to show any evidence purchases of government securities at the time the loan of was put on, although undoubtedly on many occasions the borrowing was necessary to meet War Loan calls. We shell continue to watch the trend of member bank borrowings and discuss with the borrower any unusual activity. Very truly yours, ( 01/4441,.° • e S. BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM WASHINGTON 25, D. C. ADDRESS OFFICIAL CORRESPONDENCE TO THE BOARD *4Niaga April 19, 194.5 Dear Sir: In recent months there have come to the attention of the Board of Governors from several districts instances of borrowings by member banks from Federal Reserve Banks on Government securities as collateral, under circumstances which indicated that one of the purposes, if not the principal one, might be that of increasing "borrowed capital" in order to lessen or avoid excess profits taxes. It may be observed in this connection that the regulations of the Bureau of Internal Revenue provide that "Indebtedness included in borrowed capital must be bona fide. That is, it must be incurred for business reasons and not merely to increase the excess profits credit." Illustrations of the kind of transaction that raised the question have been presented by reports that member banks had discounted with Reserve Banks their notes for very large amounts secured by short-term Government obligations currently purchased in the open market. Aside from any profit due to the difference between the discouAt rate and the yield upon the securities used as collateral, it was apparently thought that the amounts borrowed would enable the borrowing banks in their income tax returns to set up average indebtedness that would be sufficient to produce some savings in, or to eliminate entirely, excess profits taxes which otherwise would be applicable. While the practice mentioned above appears to be in its infancy, it has the possibility of further growth as member banks approach from an earning standpoint the exposure to the excess profits tax. The Board of Governors, in bringing this matter to your attontion, suggests that you arrange to review any unusual application for discount facilities and ascertain before granting the discount whether the reasons for such oPvIcrORYapplication are consistent with the proper needs of the bank for BUY STAMPS FOil FILLS Gladyn Clo ----------L-121L-- I • • • 2 replenishing reserves. The application may come after the applicant bank has purchased or committed itself to purchase new securities. Under such circumstances, you may feel that it is advisable to grant the accommodation temporarily in order to avoid undue embarrassment to the applicant bank. If so, a maturity date should be fixed which will allow the applicant only sufficient time to liquidate the purchases in an orderly manner. Very truly yours, P.-()_,&/.4) Chester Morrill, Secretary. TO THE PRESIDENTS OF ALL THE FEDERAL RESERVE BANKS. ) e-tit APR 19 1945 Dear Sir: In recent months there :ave coie to the attention of the Board of Governor from several districts instances of borrowing:3 by member banks from Federal Reserve Banke on Governeent securities as collateral, under circumstances which indicated that one of the purposes, if not tne principal one, might be that of increasing "borrowed capital" in order to lessen or avoid excess profits taxes. It may be observed in this connection that, the regulations of the Bureau of Internal Revenue provide that "Indebtedness inclueed in borrowed capieal muet be bona fide. That is, it must be incurred for businese reasons and not merely to increaae the excess profits credit." Illustrations of the kine of transaction thae raised the question have been presented by reports ehat meeeber banks had discounted with Reserve Banks their notes for very large amounts secured by short-term Government obligations currently purcnased in the open market. Asiae from any profit due to the difference between the discount rate and the yield upon the securities used as collateral, it was apparently thought that the aaounes borrowea would enable tne borrowing banks in their income tax returns to set up average indebtedness that would be aufficiene to produce sore savings in, or to eliminate entirely, excess profits taxes which otherwise would be applicable. While the practice mentioned above appears to be in its infancy, it has the possibility of furtner growth as meeber banks approach fro:e an earning standpoint the exposure to the excess profits tax. The Board of Governors, in bringing this zatter to your attenre tion, suggests that you arrange to review any unusual application for discount facilities and ascertain before granting tee discount wheteer the reasons for such application are consistent with the i'ro.per needs of the bank for replenishing reserves. The application may come after the applicant bank has purcnases or coeeitted itsell to purchase new securities. Under such circumetances, you may feel that it is advisable ,, U18 Glcver -2— to grant he acccyziodation te::pora rily in order to avoia undue embarrassLent to the applicant bank . if so, a maturity date should be fixed which will allow the appl icant only sufficient tie to liquidate the purchases in an orde rly manner. Very truly yours, Signed) Chester iViorrii; Chester Morrill, Secretary. s.tyrks oN 7," R 19 1945 • 11110 JIPPROPO iltest et Mr. 1110. Mr. McKze 1111% : Mr. Mr. 1'.;:rsrt If you Eiprksoir. ! ui in.; youn aq Mrs. Fluassali 10 illESIOLNTS OF ALL TU. FEDEftAL HLbE itVE ? S. TENTATIVE DRAFT OF LETTER TO THE PRESIDENTS OF ALL FEDERAL RESERVE BANKS. In recent months there have come to the attention of the Board of Governors from several districts instances of borrowings by member banks from Federal Reserve Banks on Government securities as collateral, under circumstances which indicated that one of the purposes, if not the principal one, might be that of increasing "borrowed capital" in order to lessen or avoid excess profit taxes. It may be observed in this connection that the regulations of the Bureau of Internal Revenue provide that "Indebtedness included in borrowed capital must be bona fide. it must be That is, incurred for business reasons and not merely to increase the excess profits credit." Illustrations of the kind of transaction that raised the question have been presented by reports that member banks had discounted with Reserve Banks their notes for very large amounts secured by short-term Government obligations currently purchased in the open market. Aside from any profit due to the difference between the discount rate and the yield upon the securities used as collateral, it was apparently thought that the amounts borrowed would enable the borrowing banks in their income tax returns to set up average indebtedness that would be sufficient to produce some savings in, or to eliminate entirely, excess profits taxes which otherwise would be applicable. While the practice mentioned above appears to be in its infancy, it has the possibility of further growth as member banks approach from an II • • -2- earning standpoint the exposure to the excess profits tax. The Board of Governors, in bringing this matter to your attention, suggests that you arrange to review any unusual application for discount facilities and ascertain before granting the discount whether the reasons for such application are consistent with the proper needs of the bank for replenishing reserves. Uur fi14t information may come after the applicant bank has purchased or committed itself to purchase new securities. Under such circumstances, you may feel that it is advisable to grant swell accommodation temporarily in order to avoid undue embarrassment to the ad e 104Za• 4>ge'"44 applicant bank. If so, nly sufficient time to liquidate .1! - •• • • ed as -the- !.s ThNTeTIVL DRAFT OF LETTER TO THE PRE6IDENTS OF eLi FEDERAL RE6ERVE bANK3. In recent months there have come to the attention of the eoera of Governors from several districts instance s of borrowings by member bank., from Federal Reserve Lanks on Governme nt securities as colleteral, under circumstances which indicated thet one of the purposes, if not the principal one, might be that of incree3in4 "borrowed capital" in order to lessen or avoid excess profit taxes. It may be observed in this connection that the regulations of the Bureeu of Internal Revenue provide th-t "Indebtedness included in borrowed capital must be bona fide. it must be Thet is, incurred for business reasons and not mere ly to increase the excess profits credit." Illustrations of the kind of transaction that raised the question have been preseneea by reports that memb er bank h,d diecounted wite Reserve donks their notes for very lerg e amounts secured by short-term Government obligations currently purchased in the open market. aside from any profit due to the difference eetween the discount rate end the yield upon the securities used as collateral, it was apparently thought that the amounts borrowed would enable the borrowing banks in their income tax returns to set up average indebted ness that woula be sufficient to produce some savings in, or to eliminat e entirely, excess profits taxes which otherwise would be applicable. '61ei3e the practice mentioned above appears to be in its infancy, it has the possibility of further growth as member banks approach from an -"4- eLlming standpoint the exposure to the excess profits tax. The 2c)ard of Governors, in bringing this matter to your attention, suggests th;.t you arrange to review any unusual application for discount facilities and ascertain before granting the discount whether the reasons for such application are consistent with the proper needs of the bunk for replenishing reserves. Your first information may come after the applicant bank has purchased or committed itself to purchase new securities. Under such circumstances, you may feel that it is advisable to grant such accommodation temporarily in order to avoid undue embarrassment to the applicant bank. If so, to liquidate such ••• • only sufficient time vrx11 pvided-th 11113ARD OF GOVERNORS S. OF THE FEDERAL RESERVE SYSTEM Office Correspondence To Members of the Board From Date April 9, 1945. John K. McKee Subject: Bills Payable - Member Banks There apparently seems to be an occasional case coming to the attention of the staff, which indicates that member banks are borrowing sizable sums of money comparable to their total resources and for reasons other than to meet withdrawals and replenish required reserves. To date, I have been reminded of cases in the Dallas, Atlanta, and Richmond Districts, believing that this idea of borrowing money for obtaining a larger tax base, in connection with excess profit, is growing. I believe our experience to date as to what we have seen on this subject warrants one or both of the following actions: (1) That the Board advise all Federal Reserve Banks that such requirements for borrowed money have been evidenced in certain sections of the country, and that the Reserve Banks should scrutinize carefully the reasons for any such borrowings and decide accordingly whether to grant the credit and, if so, to curtail its maturity, which would allow for the liquidation of the over-investment that caused such borrowings. (2) That the in connection with Revenue. It would them as to whether would or would not base. matter should be placed before the Treasury its responsibility for the Bureau of Internal seem logical that a ruling should be made by borrowed money by banks for this purpose be considered as an enlargement of the tax for information prior to consideration at a Board meeting. I FOR NRMAVON Mr. Bans Mr. EV3!I'L Mr. Thurston. Please 110t2. OA* and return to Mrs. Fitzgerald I 1 1_,:,..(.7, • Glacl'Ye • • 11 The Kanawha Valley Bank, Charleston, West Virginia. Date of Examination: February 19, 1945. Statement of Condition: LIABILITIES ASSETS Cash and exchange U.S. Govt. securities Other securities Loans and discounts Fixed assets Accruals, etc. Other assets 411,098,900 47,651,800 69,700 5,424,500 440,000 22,800 241,400 Deposits: Demand Time Public funds 433,028,700 7,005,000 17,561,900 57,595,600 Borrowed money Reserve Bank Other liabilities Accruals, etc. CIFETItal account - 465,523,100 465,573,100 CONFIDENTIAL SECTION ”Since the previous examination this bank has borrowed amounts . from 41,00J,000 to $5,200 000 for a n days, raaElly averace maturity five days. Reasons for borrowing were given as, (1) temporary loan to avoid disturbing investmer_t program, (2) to increase earninc-s (borrowed at 1/Zi2, receiving 7/8% on certificates), (3) hope to derive some benefit by increase in excess profits tax base. Executive Vice President Picklesilder said some securities I\ould probably be sold in the near future and borrowing discontinued." , Gladys Glover . March 5, 19145. Mr. W. J. Davis, Vice President, Federal Reserve Bank of Philadelphia, Philadelphia 1, Pennsylvania. Dear John: Referring to our telephone conversation, I am quoting below, for your information, an excerpt from a letter we recently wrote to Mr. McLarin, President of the Federal Reserve Bank of Atlanta. "The first question, as your Counsel points out, depends upon whether securities held by a third party (in this case a New York City bank) may be validly pledged with the Federal Reserve Bank of Atlanta by a member bank seeking a loan from the Federal Reserve Bank if the securities remain in the possession of the New York bank. Your Counsel answers this question in the affirmative and the answer appears to be correct as a matter of law. In view of the desirability of affording proper services to member banks, and in view of the risk, expense and delay incident to the shipment of negotiable securities, the Board will interpose no objection to the suggested procedure. However, the Board feels that the use of the procedure should not be encouraged. Moreover, in view of the availability of C.P.D. transfer with respect to bills, notes and certificates of indebtedness being sold, the reasons for adopting the procedure with respect to them are not as strong as with respect to bonds, and therefore, the Board feels that the use of the suggested procedure with respect to the former should be discouraged and restricted to a minimum." Trusting that the above gives you the information you want, I an Sincerely yours, E. L. Smead, Director of Bank Operations. Division ELS:jbs „ 4) - FER 8-'12;7) geee_ 4 February 6, /9/ 5. General Files Mr. Chase U. S. bonds held. in New York as collateral for Federal Reserve Bank of Atlanta Pollard Turman telephoned me this morning with further reference to my letter of January 20 in connection with the above subject. He said that before writing the Treasury asking them whether it would be all right to have the receipt run to the Federal Reserve Berle, rather than to the Federal Reserve Bank as Fiscal Agent, in cases where all or part of the securities were held as collateral for the War Loan Account, he and Mr. Bowman had thought it best to inquire from us whether we had any fear that the proposed inquiry might upset some existing arrangement wheh other Federal Reserve Banks might have made. He also wondered whether we would be willing to try to get some indication of the Treasury's attitude by telephone on a purely inforeial basis before he wrote. I discussed the matter with Mr. Smead and he thereupon telephoned Mr. Edward D. Batchelder in Under Secretary Bell's office, and Mr. Batchelder said that he felt sure that it would be all right for a Federal Reserve Bank to take a receipt running to the Federal Reserve Bank, rather than to the Federal Reserve Bank as Fiscal Agent, in either case, and that although the Federal Reserve Bank could write in to the Treasury if it wanted to, if he were in the Bank's place he would simply go ahead. I relayed this information to Pollard Turman, who was grateful. He indicated that he would go ahead on that basis, without writing to the Treasury. GHC:am 7r Lmr . yri4 '• at rziera*." """ ". -" 1945 - • - Maw ito 6. ) . ; Mr. MillArd M. IL 1111koe ak Attached for your information Wig copy of a)latter_trim. riesident *Mote dated December 0 ,y04 ragarding the-iiiii of the .1 Reserre Vall— si froiricial bank in New York•receipt aablipt— describing securities that seri* as eollateral to a leem mode to a member bank MA the Board's repair Jammeff 3. 1945. kot • "*. AA IF u/,. C 47 1 1, IAN 4 JAN 3 194b Mr. Malcolm H. Bryan, First Vice President, Federal Reserve Bank of Atlanta, Atlanta 3, Georgia. Dear Yr. Bryan: Thank you for your letter of January 17 enclosing a draft of receipt and a draft of agreement for use in cases where a member bank borrows from your Bank on the security of United States obligations deposited by the member bank with a New York correspondent. Very truly yours, Chester Morrill, Secretary. LAIG:am JJ 2 : D ii 1E7'3 JAN 2 `...! January 20, 1945. Mr. Pollard Turman, General Counsel, Federal Reserve Bank of Atlanta, Atlanta 3, Georgia. Dear Pollards I have received...Lour letter of January 16 regarding the Board's letter of January 3. It is always a pleasure to hear from you, and I hope I can give you the information you require. You are correct in assuming that I helped write the Board's letter and participated in the discussions. lt was contemplated that the receipt given by the New York Bank would not specify the purposes /or which the securities were pledged, and that it would run to your Bank and not to your Bank as Fiscal Agent, even in oases where the securities served as eollEteral only for the War Loan Accolmt. We were aware of the provisions of paragraph 11 of Treasury Circular NO. 92, ;ut we assumed, as stated in the letter, that if you had any doubts as to whether this could properly be done, you would notify the Treasury Department of the procedure adopted so that it might have an opportunity to question the procedure if it desired to do so. It seemed possible that the Treasury would interFrot Circular No. 92 to mean that the Reserve Bank would be acting "as Fisoal Agent" and that all details, including the form of the reueipt, wo,tidbe left to its discretion. In the course of the disoussion,:i it was pointed out that if the receipt ran to the Federal Reserve Bank as Fiscal Agent, and the member bank desired to pledge the excess securities to the Federal Reserve Bank as collateral for a loan, it would probably be necessary to obtain a new receipt, or receipts, from the New York Bank, and that the delay incident to obtaining the new reoeipts would in a large measure nullify the advantage of having the securities in New York. I believe that this is an accurate statement of the intention of the member* of the Board's staff who worked on the letter. If it does not Give you the information you need, I shall, of course, be more than i;lad to (lo whatever I can to help clear up the matter. Very sincerely yours, CnIC:RM b(i 1 FOR FILES G. H. Chao 711 1 '. jAN 225 s t j FEDERAL RESERVE BANK OF- ATLANTA OFFI r VICE P Jantriry 17, 1945. Mr. Chester Morrill, Secret-try, Board of Governors of the Federal Reserve System, Washington 25, D. C. Dear Mr. Morrill: President McLarin is out of the city for a and, in his absence, I am sending you a draft of the receipt and a draft of an agreement which we propose in cases where a member bank borrows on the security ,tates obligations deposited by the member bank with York correspondent. few days, custody to use of United a New It may be that from time to time we will revise the form of the receipt and the form of the agreement if, from experience, it appears that such revisions are necessaryor appropriate. These documents are being sent to you in accordance with the request contained in your letter of January 3, 1945, addressed to Mr. McLarin. Cordially yours, Enclosures -2 FV?..DITENSE c BUY UNITED STATES SAVINGS BONDS AND STAMPS , CIEMY RECEIPT No. Date TO: FEDERAL RESERVE BANK 1F ATLANTA: The undersigned bank or trust company has received, rid holds in custody, for your account fld subject exclusivel:r to your written order and direction, the securities described below: Said securities were received by the undersiP .ned from . Until otherwise instructed by you in writing, the undersigned will surrender to the bfmk from which the securities were received maturing coupons, if v.ny, on slid securities. RECEIPT IS NONTRANSFERABLE AND NONNEGOTIABLE. By ST.TE OF COUNTY OF KNOW ALL MEN BY THESE PRESENTS, Th. t the undersigned, owns negotiable securities 7hich 1 e oblig tions of the United ,t. ‘ ,tes and has snid securities in the custody of a corresiondent bank or brinks boated in the City of Ner York (eny one of said banks will hereinafter be referred to as "Custodian"); That the undersigned, from time to time, my rnke applic tion to the Federal Reserve Bank of Atlanta (hereinafter referred to f's "Reserve Bank") for loans under the provisions of Section 13 of the iedere.1 reserve Act, as amended (and may desire. to pledge all or a portion of said securities as collateral to such loans .trid, for reasons beneficial to the undersie..ned, may reeueet the Reserve Brink to nermit a Custodian to hold the securities If serving as collateral to said loins for the account, end subject exclusively A to the written order and direction, of the Reserve- Benks. NOW, THEREFORE, In consideration )f the premises and to induce the Reserve Rink, in the making of loans to it as aforesaid, to eermit a Cuetodian to hold said securities for the account', .rid subject exclusively to the written order and direction, of the Reserve Rank, tae undersiFned hereby agrees as follows: 1. Thet a Custodian having in its possession securities of the undersigned pledged to the Reserve BrIk as collateral to a loan made pursuant to the provicions of Section 13 of the Federal Reserve Act, .as amended, will held said securities for the account, .:nd subject exclusively to the written order and direction, of the Reserve Bank. -2- 2. That assumes full resnonsibility for the safekeeping and custody of said securities by the Custodian. 3. That the Reserve Bank shell not be liable for any act or acts of. said Custodian which, directly or indirectly, result in or cause a. loss of any of said securities. 4. That if, at any tille when a loan to the undersiemed is outstanding Lnd secured by collateral held by a Custodian, the Reserve B-nk makes proper demand upon the Custodian for the delivery of said securities and the Custodian shall fail or refuse to deliver immediately said securities to the Reserve Bank, in that event the undersigned will pledge and deposit 7ith the Reserve Bank, upon re-auest, other and additional securitiesp as collateral for any such loan, in iuested by the Reserve Bank, or aill forth— the amount rewith nay said loan in full. 5. That any loss of any securities held by a Custodian eur— suant to the terms of this agreelent which may result, directly or indirectly, from the acts of the Custodian, shall not in any manner impeir or lessen the liability of the undersigned under any loan which viy be secured by said securities. It is understood that the Reserve Bank is under no obligation to permit the securities ledged by the undersi--ned as collateral fsor loans, made pursuant to the provisions of Section 13 of the ieder-1 Reserve 4ct, as amended, to remain in the possession of a Custodian, but may agree 7 ith , , the undersigned that the securities may be so held in us sole and absolute 1_ discretion. IN 7ITNEFS WHEREOF, The undersigned has caused these presents to be executed by its duly authorized officers slid its corporate se-1 to be hereunto affixed, this the day of ATTEST: By (Corporate Seal) ,19 • • - FEDERAL RESERVE BANK OF ATLANTA OFFICE OF COUNSEL Janu lry 16, 1945. , Mr. Howland Chase, Attorney Board of Governors of the Federal Reserve System Washington 25, D. C. Dear Howland: You were good enough to telephone me about the question presented by Mr. McLarin relating to the acceptance by this Bank of receipts from New York banks describing United States obligations that serve as collateral to loans made to a member bank under the provisions of Section 13 of the ilederal heserve Act. I presume th'It you had a large share in the drafting of the letter on this subject to Mr. McLarin bearing the date of January 3, 1945. Because of this I should like to impose upon you by asking if you will clarify for me a certain portion of that letter. I refer to the sentence on page 2, reading as follows: "It is understood that the receipt given by the New York bank will not specify the purpose for - which the securities are pledged, and that it will run to your Bank and not to your Bank as Fiscal qgent." VICTORY I interpret the above sentence to mean that if a member bank has securities deposited with a bank in New York and the sedurities serve both as War Loan collateral and as collateral for a loan made to the member bank by this Bank under the provisions of Section 13 of the Federal Reserve Act, the receipt from the New York bank should not specify that the securities are collateral either for War Loin or a Section 13 loan. It is not my interpretation of that sentence that where the securities serve only one purpose it would be improper for the receipt to refer to the purpose for which the securities are pledged. BUY UNITED STATES S V1NGS ONDS AND STAMPS ; 6 • T•J'i • • -,•••••••••••••••'' AL RESERVE BANK OF ATLAN•0 •• Mr. Howland Chase, Attorney #2 ' 1-16-45 I shall appreciate your comments regarding my understanding of the meaning of the sentence. I hesitate to accept a receipt from a New York bank covering securities serving as collateral to a member bank's War Loan account where the receipt does not show the securities as having been pledged by the member bank to the Federal Reserve Bank as Fiscal Agent,or at least that the Bank holds them for this Bank as Fiscal Agent. My New feeling is based upon the language contained in Paragraph 11 of Treasury Department Circular No. 92. That paragraph provides, in part, that a Custodian within the United States designated by a Federal Reserve Bank may hold securities accepted as War Loan collateral under such terms and conditions as the Federal Reserve Bank may prescribe "subject to the order of such Federal Reserve Bank or Branch as Fiscal Agent of the United States." My feeling is that the Treasury Department . in wording the circular intended that the securities would be held for the Federal Reserve Bank as Fiscal Agent of the United States and that the custodian bank should know that it was acting in behalf of the Federal Reserve Bank as Fiscal Agent of the United States. If you have any thoughts on this point I would be most happy to have you write to me. Recently we prepared a form of receipt and a form of agreement to be used in cases where a member bank borrows under Section 13 oá' the Federal Reserve Act and pledges United States obligations held by a New York bank. Shortly, copies of the receipt and agreement will be forwarded to the Board of Governors in accordance with the request contained in the letter of January 3. With highest personal regards and best wishes, I am Cordiall yours, dztaA-ik ollard Turman General Counsel II:VICTORY BUY „fit UNITED STATES SAVINGS ONDS AND STAMPS - 4: Po C (7 ot r , •__ JAN 3 1945 4r. Vt', S. MoLarin, Jr., President, Federel Reseeve Bank of Atlanta, Atlanta 3, Georgia. Dear Mr. MoLarins Your letter of Deoesiber 6 enclosed two memoranda relating to the right of the Federal Reserve Bank of Atlanta to accept from a commercial bank in New York a receipt deeeribine United States obligations that serve as collateral to a loan made to a member bank under the provisions of section 13 of the Federal Reserve Act. A related question was raised in one of the memoranda which you enclosed and another is referrnd to in the report of examination of your bank and was mentioned by you at the time of the Presidents Conference. These three questions are discussed below. The first question, as your Counsel points out, depends upon whether securities held by a third party (in this case a New York City bank) may be validly pledged with the Federal Reserve Bank of Atlanta by a member bank seeking a loan from the Federal Y.eserve Bank li the securities remain in the possession of the New York sank. Your Counsel answers this question in the affirmative and the answer appears to be correct as a matter of law. In view of the desirability of affording proper services to member banks, and in view of the risk, expense and delay incident to the shipment of negotiable securities, the Board will imerpose no objection to the suggested procedure. However, the Board feels that the use of the procedure should not oe encouraged. Moreover, in view of the availability of C.P.D. transfer with respect to bills, notes and certificates of indebtedness being sold, the reasons for adopting the procedure with respect to them are not as strong as with respect to bonds, and therefore, the Board feels that the use of the suggested procedure with respect to the former shouli be discouraged and restricted to a minimum. It is noted from the memoranda which you enclosed that your Counsel is working on a form of receipt to your bank from the New York bank and is also considering an agreement to be made between the member bank making application for a loan and your bank by which the member bank would agree to assume responsibility for any neeligence or wrongful act committed by the New York bank in holding the securities. It will be appreciated if you will advise the Board as to the form of receipt and the agreement finally ado ted, together wtth any other details of the procedure which may be d C I 17 ;71-1 -, 7 C-1,t4s Mr. W. S. MCLarin, Jr. The second question, which is raised in the memorandum of your Counsel, is whether, when bonds are pledged, in the manner above described, to the Federal Reserve Bank, as Fiscal Agent of the United States, as security for the War Loan Account of the member bank making the pledge, and, because of the size of the War Loan Account, all of the bonds are not required to serve as collateral, it is possible to pledge the excess seourities to the Federal Reserve Bank as collateral for a loan to the member bank by the Federal Reserve Bank under the applicable provisions of the Federel Reserve Act. The legal question is similar and the answer is likewise in the affirmative. Consequently, the Board will offer no objection. It is understood that the receipt given by the New York bank will not specify the purpose for which the securities are pledged, and that it will run to your Bank and not to your :2ank as Fiscal Agent. It is also understood that your 9ank will always have specific instructions from the member bank, on the basis of which the records of your Bank will show, specifically, what securities are pledged as collateral, respectively, for the Tar Loan Account of the member bank and as collateral for its loan from your Bank. It is assumed that if there is eny question as to whether the form of receipt i;iven by the New York Lank to your Bank, or any other detail of the procedure, conforms to the requirements of Treasury Department Circular No. 92, you will notify the Treasury Department of the procedure adopted so that it may have an opportunity to question the procedure if it desires to do so. The third question arises out of the fact that the Trust Company of Georgia has been placing bonds owned by country banks in safekeeping with one of the Trust Company's correspondent banks in New York City, as a service to the country banks. Safekeeping receipts for these bonds are issued by the New York bank in the name of the Trust Company of Georgia. The question is whether the Reserve Bank as Fisoal Agent of the United States should accept these receipts as collateral to War Loan Deposit Accounts in the country banks, which are the actual owners of the securities. Although it would be legally possible to protect the rights of all parties, the Board is of the opinion that the practical and operating difficulties make it undesirable to follow this procedure. FOR APPROVAL Very truly yours, 'ITES N\ 3 (Signed) Chester Moiri Chester Morrill, Secretary. First of Mst4orcifr Ct. 1_4_4 / c.Ransom 5 Mr. Szymczal.. ... McKee ........ Mr, Draper . Mr. Evans 4-84vton . ..... If you approve, pi ase Initial and return to Aggerri. Fitzgerald •• , • Treasury Circular No. 92 which deals with "War Loan Deposit Accounts" contains the following provision: CUSTODY OF SECURITIES 11. All securities accepted as collateral security for deposits hereunder must be deposited with the Federal Reserve Bank or branch of the district in which the depositary is located, as fiscal agent of the United States, or by the direction of and subject to the order of such Federal Reserve Bank or branch, as fiscal agent of the United States, with a custodian or custodians within the United States designated by such Federal Reserve Bank, and under such terms and conditions as it may prescribe. 7/ 1,3%. -7 71: rerr. ,. •WARD OF GOVERNORS OF THE 7,N FEDERAL RESERVE SYSTEM Office Correspondence To Date Subject: General Files December 2Q, lciji Pledge of Securities Held 'Isewhere From Mr. Chase Mr. McLarin's letter of December 6 raises the question whether securities held in New York may be pledged to the Federal Reserve Bank of Atlanta by one of its member banks. The affirmative answer suggested by Yr. Turman appears to be entirely justified in view of Pierce v. National Bank of Commerce, 268 Fed. 467, Irving Trust Co. v. Commercial Factors Co., 68 Fed. (2d) 8646 866 (1934), and Robinson v. Exchange National Bank, 31 Fed. Supp. 350 (1940), particularly the Irving Trust Co. case. 3 (i trr. • • rAN , FEDERAL RESERVE BANK OF ATLANTA OFFICE OF PRESIDENT December 6, 1944. -64 iX0 Mr. Chester Morrill, Secretary, Board of Governors of the Federal Aeserve System, Washington 25, D. C. Dear Mr. Morrill: There are enclosed two memoranda relating to the right of the Federal Reserve Bank of Atlanta to accept from a commercial bank in New York a receipt describing securities that serve as collateral to a loan made to a member bank under the provisions of Section 13 of the Federal Reserve Act. At the forthcoming Presidents' Conference I propose to undertake to have this matter discussed, and it is likely that the questions raised may be considered at the time of the conference between the Presidents and the Board of Governors. In order that you may have an opportunity to consider the mat— ter in advance of any discussion which may take place in this connection, I thought it advisable to send the enclosed memoranda to you. Very truly yours, eYILLari l President. Enclosures —...----.......--, roll FILES ov or Cl.7.3ys GI r _ • :.71 \ • "ovember 28, 1944. Trust receipt of a New York commercial benk covering Government securities as collateral to direct advance made by Reserve Bank to its member bank Section 13 of the Federal Reserve Act recites that a Federal Reserve Bank may make advencee Le its member banks on their promiscory notes secured by the deposit or pledge of United States obligations. The Board Exaainers have questioned our action in accepting trust receipts of Nee ruck bunko covering Government obligations 46 lull compliance with the law. They also bring up the question of using notes so secured as collateral to the issuance ef Federal Reserve currency sine. such auvances witl normally be pled, ; ;ed to the Federal Reserve Agent s a portion of the Reserve Bank's collateral to its outstanding Federal Reserve notes. This memorandue does not purport to cover the legal question raised, as that should be covered by Counsel. It does set forth the practical aspect of the situation as it prevails in connection with this benkle endeavor to serve adequately the member banks in the Sixth Federal Reserve District. There is no adequate market for United States Government securities in the south and, as a consequence, a large number of our member banks desire to hold a good sized block of Government securities in Nee York commercial banks, C. P. D. deliveries apparently co not serve the banks with all of the facilities desired. The Treasury Department will deliver free one time etee, certificates Lulu bills provided such securities have been deposited in the War Loan collateral account since issue date. C. P. D. delivery may also be made of notes, certificates, anu bills if the oening bank certifies they are covered ; by a sales contract requirint delivery in a Reserve Bank or branch city. Bends may not be transferred by C. P. D. except for origin 1 allotment delivery only. 111 I, Page 2 The transf-r of securities in any other menner except by C. P. D. is prectically prohibitive because of the high postal surcharge. Vie have considered a trust receipt of a selected New York commercial bank to be quite analogous to a cotton warehouse receipt as representing col— lateral security, in so far as loan collateral is concerned, in approaching the use of the receipt for the United States bonds. It may be stated that in the cuee of cotton warehouse receipts the Reserve Bank will have the name of the borrower anu the name of the discounting bank as secondary protection in the event the cotton represented by the warehouse receipt is lost or stolen. Technically this is correct, but from a practical standpeint so—called cotton commodity loans have not been made on the basis of underlying financial etrenoth of the borroeer but primarily on the value of the security. This removes, in most instances, thr ,orth ef the borroeer and leaves only the bank name. In accepting "warehouse receipts" oi a New York commercial bank coveriog the "storage" of Government securities we can expect to have some real North value in the name of the "warehouseman" (the bank) in audition to the name oe our discounting member bank. It would appear, however, that we should probably enter into a more or less formal contract with our discounting member bank, having it designate the New York commercial bank as its agent anu our agent, the member bunk to assume all responsibility for bad faith on the part of the New York commercial bank. Counsel and the undersigned have been working on a form of receipt we feel should be usea, ane it eoula be obligatory on our member bunk to have the New York commercial bank issue such form of receipt to us. If some such method cntiot be formulated to assist our member banks it is obvious they will be pemllihed by not beini; located close to a major •• Page 3 money market. It will restrict their ability t.) borrow thro14- the Federal Re:1 serve Bank of their district and compel them to either (1) t:..ke delivf:ry of their securities in the Sixth Federal Reserve District Lnu pay the high surcharge costs to ship them; or (2) borrow from their NeY, York correspondents; or (3) sell the securities on the market in New York whenever they are required to adjust their reserve position. The Treasury Department of the United States has recognized the uifficulties confronting the commercial banks in the acquisition and holding of United St%tes securities and has authorized its agents, the Federal Reserve Banks, to accept trust recei!tu of co.,,mercial banks located outside of the respective district as representing an acceptable pledge of collateral to secure a bank's special deposit account. It appears to us that the practicalities of the situation as to the security for direct advances by Federal Reserve Banks tc. their members are quite analogous. V. K. Bowman, Vice President. VKLisTAT • • (Tentative Draft) SAFEKEEPING RECEIPT (Date) To: Federal Reserve Bank of Atlanta, 104 Marietta, N.W., Atlanta, Georgia. The undersigned hereby certifies that there have been delivered to it and it now holds, for the Federal Reserve Bank of Atlanta, the following described securities which ape payable to bearer: The above described securities were received from All of the above described securities and any securities substituted therefor with your prior written approval, will be held by the undersigned subject exclusively to your written order; provided, however, that,until the undersigned is otherwise instructed in writing by you, maturing coupons on said securities may be surrendered to the bank which delivered the securities to undersignea. This receipt is non-transferable. By Official Signature City State 0 • r , f December 6, 1944. To: Mr. V. K. Bowman, Vice President. From: Pollard Turman, General Counsel. The question has been asked which may be stated as follows: where the Federal Reserve Bank of Atlanta makes a loan on the security of collateral specified in Section 13 of the Federal Reserve Act and Regulation A, is it permissible for the bank to receive a safekeeping receipt from another bank reciting that such other bank holds the collateral subject to the exclu— sive order of the Federal Reserve Bank of Atlanta? Section 13 and Regulation A provide, in connection ith loans secured by obligations of the United States, that promissory notes evidencing loans made by the Federal Reserve Banks shall be secured by "the deposit or pledge of bonds, notes, certificates of indebtedness, or Treasury bills of the United States", etc. The application of the member br-lak for a loan secured by government obligations contains a pledge of the securities of the United States which are to serve as collateral for the loan, and in the usual case the securities would be deposited with the Federal Reserve Bank until ' the loan has been repaid. Under such circumstances, there could be no question but that the securities were "deposited or pledged." At the present time, a large percentage of the assets of the commercial banks of the nation are in the form of securities issued by the United States of America. For the most part, the securities are negotiable and it is essential, therefore, that they be handled with the utmost care and, when transported from one place to another, that they be covered with adequate insurance against loss. Due to the fact that the securities .are, r RILES Clover • • for the most part, negotiable, recovery is difficult in case they are lost or misplaced. Moreover, they are desirable to persons who may be inclined to steal. Accordingly, it would be prudent for the owner of such securities not to ship them from place to place unless absolutely necessary in view of the hazard and expense involved in such shipments. Moreover, the buying and selling of government securities "in the market" takes place almost exclusively in New York City. It follows, therefore, that a bank, in handling its investments, prefers to have them safely stored in a New York bank. The question then arises, is it legally permissible for a Federal Reserve Bank to lend to a member bank on the security of obligations physically located in New York City? It would seem that the answe to the question de- pends upon the meaning of the words, "deposit or pledge", as used in Section 13 and Regulation A. The question might also be stated, would the taking of a safekeeping receipt of a New York bank constitute a "deposit or pledge" of , the securities described in the receipt? A pledge is defined as a bailment or delivery of goods by a debtor to a creuitor to be kept until the debtor's obligation is discharged. goods. The essence of a pledge is the delivery of the Unless a legal delivery is made, there is no valid pledge. It is well settled in the law that the delivery of the property to the pledgee may be made either actually or constructively. Actual delivery would be the trans- fer by the pledgor to the pledgee of physical possession of the property pledged. Constructive delivery takes place where the pledgee is placed in t; position to exercise control and dominion over the possession of the property. For example, the placing in the hands of a pledgee of a negotiable warehouse 3 • receipt gives the pledgee control over the property ana a suZficient delivery has been made to cmstitute a valid pleage. Similarly, the delivery by the pledwor to the pledgee of the key to the building in which goods are stored has been held to be a legal pledge of the goods stored in the build— ing. It is my opinion that a oroperly worded safekeeping receipt issued to the Federal Reserve Bank of Atlanta by a New iork bank, describing the securities pledged by a. member bank as cbliaterai to a note representing an advance under the provisions of Section J3 of the Federal Reserve kct, is a valid pledge of such securities and complies vdth the requirements of the Federal Reserve Act and -]jjeguiation A. It should be pointed out, however, that the New York bank, under the circumstances set forth above, holds the securities for the Federal Reserve Bank of Atlanta; and if it should commit an act of negligence or other unlawful act which results in the loss of the securities, such loss would fail upon the Federal Reserve Bank. T.,lu question, then, of policy is raised--whether in all cases the Federal. Reserve Bank would be satisfied in receiving a safekeeping receipt issued by a New York bank. As a means of eliminating this aifficuity, it is possible for an agreement to be reached between the member bank making aoJiication for a loan and the Federal Reserve Bank, by the terms of which the member bank agrees that the Federal Reserve Bank will not be resoonsible for any negligence or wrongful act committed by the New York bank in the safekeeping of the securities pledged as collateral to the loan. Such an agreement would seem to be justified in view of the 4 •• • 0 fact that the arrangement for allowing the securities to remain in the New York bank is entirely for the c nvenience of the member bank; and, receiving all the benefits derived therefrom, it should shoulder such burdens as are attendant thereto. A related question also arises in connection with this matter as follows: tains a if a member bank of the Sixth Federal Reserve dstrict which mainLoan Account has pledged as security for such fHccount obligations authorized by Treasury Department Circular No. •21-1(1, pursuant to the pro- visions of said circular, the Federa_L Reserve Bank has oermitted the securities to be held by a New York bank under a custouy receipt issued by the New York bank to the Federal Reserve Bank of Atlanta, as Fiscal Agent of the United States, and there are held by said New York bank securities which, because of the size of the -Var Loan Account, are not required to serve as collateral and are, therefore, "excess", may such "excess" securities be pledged to the Federal Reserve Bank of Atlanta as collateral to a loan made to such member bank under the applicable 1,)rovisions of the Federal Reserve Act? the answer to the question is in the affirmative. In my odinion, However, in order that the oledge of "excess" securities may se validly made, it is necessary that the New York bank transfer the securities from the account of the Federal Reserve bank of Atlanta, as Fiscal Agent of the United States, and issue a receipt showing that the securities are held by it in safekeeping for the Federal Reserve Bank of Atlanta. If the °ledge of the "excess" securities is made by the member bank and is snown by the records of the Federal Reserve Bank of Atlanta but is not also reflected by the records of the New York bank, there would be serious doubt 'ohether the pledge would be valid anu there is a 5 possibility that a controversy with the Treasury Department might ensue if the amount of the War Loan Account of the member bank increased without the knowledge of the Federal Reserve Bank of Atlanta and the member bank failed to pledge additional collateral as required by Treasury Department Circular No. 92. p . BOARD 041010ORS OF THE FEDERAL RESERVE SY VIT1 3K;tLION 2 t..1 ' ; ! /* r: 0 134.-: e) : e^:.1Lf - 41MM. November 16, 1944. Memorandum to the Board: Mr. Gilbert of Dallas called me this morning and said that the discount for the City National Bank of Houston which was granted on October 20 was retired in full yesterday through the sale of the securities involved. The Dallas Bank is having a meeting of all head office and h directors at Dallas today and Mr. Gilbert had hoped that Judge Elkins would be there but he is suffering from an attack of flu and y/ consequently Mr. Gilbert will not have an opportunity, which he had / ir'hoped for, to discuss the matter with Judge Elkins today. pv Incidentally, Mr. Gilbert said that Mr. Brown, of Chicago, I/444 is at the meeting as a guest to discuss the Bretton Woods plans and is on his way to Mexico City to visit a relative. With respect to the City National Bank transaction, Mr. Gilbert did not write the other Presidents about it but plans to 'discuss it informally with them during the meeting of the Presidents Conference. Secretary. ia (4( Oleak 3Z/ 1OV1 01944 ,t Novembe 1, 1944 Memorandum for the Files: ffM Ye. . ;01 ..41$014 Today at noon I talked over the telephone with President Gilbert, of the Federal Reserve Bank of Dallas, in regard to the note which the Bank had discounted for the City National Bank of Houston. I told him that my only reason for calling him up was my curiosity as to what had taken place. He said that he had discussed the matter with the executive committee and that they had agreed with his view of the situation. He then talked to Judge Elkins over the 'phone and told him how the Bank felt about the transaction, stating that it was realized that the note had been discounted for 30 days and therefore the Federal Reserve Bank would not call for its payment before maturity but that he hoped that, he light of the discussion, Judge Elkins would find some way to unthe transaction without waiting for maturity. Mr. Gilbert said that udge Elkins said that he could not disagree with the views expressed by Mr. Gilbert, that it was an undue use of credit and not a proper use of Federal Reserve credit, and that it was a very unusual transaction. Judge Elkins said that before entering into the transaction he had inquired whether there was any limit that a member bank might borrow from a Federal Reserve Bank and had ascertained that there was no limit. That being the case, he had gone ahead with the transaction from his bank's standpoint and that to pay off the discount now would entail a loss which hr/would like to avoid. He commented that when the Federal Reserve Bank ctually discounted the 30-day note he assumed that the Federal Reserve ank had no objection to the extension of credit. Mr. Gilbert told him hat they had not wished to hold up the transaction at the time when it came through; that it might have been better if they had limited it to , 3 or 4 or 5 days but that, having discounted it for 30 days, the Bank certainly did not intend to go back upon its commitment. On the other hand, he emphasized the fact that it seemed desirable in the light of all the circumstances for Judge Elkins to endeavor to find a way to unwind it. Mr. Gilbert said that they had analyzed the possibilities of loss to the City National Bank and felt that so far as the factors of premium upon the Government securities purchased, interest return, and discount paid to the Federal Reserve Bank were concerned there should not be any loss, but there still might be a loss of prospective credit in the income tax phase of the transaction. The outcome of the discussion was that Judge Elkins said that he would endeavor to liquidate the discount some time this week and as of today Mr. Gilbert has heard nothing further from Judge Elkins. Mr. Gilbert added that it was clearly understood by Judge Elkins that if it were not liquidated before maturity, it would not be renewed. Mr. Gilbert said that Judge Elkins thought that there had been other transactions of this character, probably not as large, but Mr. Gilbert had not heard of any such transactions and did not know where they were. It is possible that Mr. Gilbert will write a personal note to the other Presidents, giving them the principal features of the transaction for their information. CM yd .....i.atesds. • •••• 4111pARD OF GOVERNORS 3 11344 OF THE _ FEDERAL RESERVE SYSTEM Office Correspondence To General Files From Mr. Vest IMP limilikt/06111 41.%!Vvilt4.4, . z Dee October 24, 1944. Subject: "Borrowed capital" under Excess Profits Tax Law. I telephoned this morning to the Bureau of Internal Revenue to Carded discuss the question whether a bank which purchases Government securities and then borrows against them from a Federal Reserve Bank, ostensibly for the purpose of increasing its "borrowed invested capital" under the Excess Profits Tax Law, would be permitted by the tax authorities to consider such indebtedness incurred as borrowed capital and thus to obtain a larger credit on its excess profits net income. In this connection, U.S.C., Title 26, section 719, provides that borrowed capital includes indebtedness,not including interest,"which is evidenced by a bond, note, bill of exchange, debenture, certificate of indebtedness, mortgage or of trust", and Regulation 112, section 35.719-1 (Paragraph 5129 of -rce Clearing House Service), provides: "In order for any indebtedess to be included in borrowed capital it must be bona fide. It must be e incurred for business reasons and not merely to increase the excess rofits credit." I endeavored to talk first with one or two men with whom I am acquainted, but being unable to reach them I finally was referred to a - Tr. Ferris, who was described as a "Reviewer" and whose telephone number is Branch 406. I put the question up to him as a general one and without Statinc; that any specific bank or case was in mind. • Be said that the Bureau had had occasion to write letters in -answer to inquiries on this subject, with respect to banks and other .cerporations. The general purport of these letters is to say that no ,,c1cfinite answer can be given or general rule laid down; that the question depends on the facts and circumstances of each particular case; and thet therefore each case must be determined as it arises. If the ebtedness is reasonable in amount in relation to the size of the *.orrawer and there is likelihood of prompt repayment, it will probably be permitted to be included in borrowed capital, but if the borrowing is out of proportion to the size of the borrower or prompt repayment is not likely, or if it is not incurred for a business purpose, it will not be permitted as borrowed capital. The inquiries which have been made of the Internal Revenue Bureau have been in connection with the war bond drives, and the Bureau in answering them has had in mind that as a part of the Treasury they did not want to discourage the sale of bonds, and, on the other hand, they could not recognize as borrowed capital any indebtedness which was incurred merely for the purpose of avoiding tax. Mr. Ferris stated that, in view of the statute, the Commissioner of Internal Revenue would not have authority to say that any secured loan or secured bills payable Should be excluded from borrowed capital merely because the indebtedness is fully secured. 6 • BOARD OF GOV./DRS OF THE FEDERAL RESERVE SOE v b :fa! ir. : ) t ..Ty P F.94 t tt, 7tir c - OCT 2 C1944 October 23, 1944. Memorandum for the Files: Subject: Use of discounting facilities of Federal Reserve Bank of Dallas by City National Bank of Houston. On October 23 at 11:45 a.m. there was an informal gathering in the Conference Room for the purpose of discussing the above subject. There were present Messrs. Ransom, McKee, Draper and Evans, together with Messrs. Dreibelbis, Thurston, Robinson, Vest and Morrill. Mr. Ransom opened the discussion by referring to the call which he had received over the telephone from President Gilbert of the Dallas Bank on Saturday, of which a transcript was made by Mrs. Cotten. Mr. Ransom said that it seemed to Mr. Draper and himself that the thing to do was to say that the transaction in question was a type of use of Federal Reserve credit that we do not approve in principle and to leave it to Mr. Gilbert to decide exactly how to deal with the situation for the present, bearing in mind that if the City National Bank people should decide that it is important to them to retain the loan, we may have to take some further action. Mr. Ransom thought it would be desirable to call to Mr. Gilbert's attention the provisions of the regulations of the Bureau of internal Revenue quoted in the memorandu-n from Mrs. Cagle and Mr. Robinson, addressed to Mr. Ransom under date of October 21, 1944, to the effect that "indebtedness included in borrowed capital must be bona fide. That is, it must be incurred for business reasons and not merely to increase the excess profits credit." Mr. McKee said that he would not be satisfied to stop at this what Mr. Ransom suggested might be all that was necessary to although say to Mr. Gilbert at present. Mr. McKee thought that the matter should be brought to the attention of the Treasury Department as having come to our attention as a possible interpretation of the provisions of the tax law relating to borrowed money. Mr. McKee felt that borrowings by commercial banks were not "borrowed money" in the true sense of the term as intended by the tax statutes. In other words, he did not think that such borrowing should be treated as invested capital. Even if the City National Bank should liquidate the credit in question, Mr. McKee would still bring the matter to the attention of the Treasury Department because of its potentialities. Mr. Ransom thought that it was not necessary to raise the question at this tine if the Houston Bank should liquidate the credit promptly. He would tell President Gilbert that the Board agrees with the position which he has taken and await further developments. However, Mr. Ransom thought it would be well for Ir. Dreibelbis to find out who in the Bureau of Internal Revenue has the responsibility for handling questions of this i -1, , , .... ......,,,.. tir 1!,7 T ? • 1344 - 9 _ kind and that some informal conversation might be held for the purpose of ascertaining what might be the point of view of the Treasury if it became necessary to consider the matter further. A number of questions arose during the discussion, which led to placing a call on the telephone for Mr. Gilbert. When Mr. Gilbert was reached on the telephone he was asked a number of questions which in large part covered the information previously furnished by him on Saturday but brought out the additional fact that the note which had been executed by the City National Bank was for 30 days. Mr. Gilbert said that that was the way the note had been presented and that he felt now that he had possibly overlooked that feature of the note and that it might have been better had he required that the note be for one or two days so that the Bank would be in position of merely not having to renew the note rather than that of asking for its liquidation before maturity. However, Mr. Gilbert made it clear that he favored taking the position that the transaction was not a proper use of the credit facilities of the Federal Reserve Bank of Dallas and said that his Discount Committee was in agreement. He added that two members of the Discount Committee had left town on official business and that the Executive Committee of the Bank would be meeting in Dallas on Thursday of this week. He said that the Executive Committee included two directors but did not recall the names of the two directors who were serving at the present time and he had not yet consulted any of the directors of the Bank about this transaction. After a prolonged discussion, he reached the conclusion that he should call these directors on the telephone and lay the situation before them for the purpose of ascertaini'lg whether they were in agreement with his position, or not, before taking the matter up with the City National Bank. Mr. Ranscim felt that it was desirable, if the members of the Executive Committee were in agreement, to make the Bank's position known to the City National Bank as promptly as possible so that it would be more effective than if there were a substantial delay. It was made clear to Mr. Gilbert that the four members of the Board who were present were in agreement with him on the position which he had taken. It was understood that if it should develop in his conversations with the directors who were on his Executive Committee that there was a difference of opinion, he would not take the matter up with the City National Bank without first discussing it again with the Board of Governors. He said that in any event he would keep the Board informed of the results of his discussions. During the conversation the provisions of the regulations of the Bureau of Internal Revenue were quoted to Mr. Gilbert and the citation of the particular regulation as well as the place in the Commerce Clearing House reports where it would be found was given to him. Mr. Gilbert apparently had not seen these provisions and was pleased to receive the information, which he felt strengthened his position. . T.77.,. 1'71 ,,TT-m1044 3 There was some discussion of the method by which Mr. Gilbert would communicate his position to the City National Bank, his thought apparently being that he would do so in the first instance through the Vice President in charge of the Houston Branch and only take a part in it personally if the initial conversation should develop any reluctance on the part of the City National Bank to liquidate the credit immediately. It was brought out during the discussion that the President of the City National Bank is the head of one of the largest law firms in the South and that, although the borrowing was handled by a Vice President of the bank, it was probably the case that the step had been taken under the advice or guidance of this law firm, which very likely controls the affairs of the bank. The question to what extent other banks might avail themselves of a similar opportunity to reduce their tax liability was also discussed, Mr. Gilbert saying that he thought it possible that there were other banks in the Dallas district, although he did not have exact information. Mr. Robinson reported that the studies of his Section had not developed to the point where they could say exactly how many banks there would likely be in the excess profits category this coming year but that he thought the information indicated from 50 to 100 banks in the United States might have sufficient earnings. In response to a question as to whether Mr. Gilbert had any uncertainty in his own mind about his position, he said that the only uncertainty was as to what effect the attitude of the Federal Reserve might have upon the relations of the System with the Treasury and that in turn would depend upon how the Treasury looked upon a transaction of this kind. Mr. Gilbert said that he had not so far discussed the matter with the Chief National Bank Examiner at Dallas because he wanted to crystallize his own views and ascertain those of the Board first. However, it was his judgment based upon his estimate of the Chief National Bank Examiner and his experience with him that the Chief National Bank Examiner would look upon the transaction in the same light as he, Mr. Gilbert, does. Mr. McKee adhered to the view which he had previously expressed that the broad question of policy involved should be discussed with the Treasury regardless of the outcome of the particular transaction with the City National Bank of Houston while, on the other hand, Mr. Ransom hesitated to take any action in that direction for the time being. No final conclusion was reached as to this aspect of the matter. Later, in separate telephone conversations with me by Messrs. Ransom and Draper, the thought occurred to us that it might be advisable somewhere along the line to inform the Presidents of the other 11 Federal Reserve Banks regarding this transaction and what had been done about it so that they might be forewarned in case of similar developments in their own districts. DigitizedCM FRASER for yd Secretary. : Ii " '...! VT- 1 41- •!'. ") 1:144 - • •4 October 21, 1944. To: Board Members (Individually) and Messrs. Clayton, Thurston, and Morrill From: Amme I. Cotten Mr. Ransom asked me to send you a copy of memorandum dated October 21 from Mrs. Cagle And Mr. Robinson on the subject of "Use of Federal Reserve cledit as borrowed invested capital VD reduce or eliminate the incoTe subject to the excess profits taxeg," so thnt you would have an opportunity to consider it before the (3ard meets today to discuss a reply to Yr. Gilbert of Dallas on the matter that the board discussed informally on Saturday. Attachnent 1 II Port leill413 A. I. OCITTAF Li) y F t c 4 02 ...e..-- .9,..,......., .17--,_,Q.."..._ L._ C .--) .... c-.. . MIZ -7/ 77) 1 A • . 40 y3 .,,,:rr,-1•7 JAN 1__ "1/-7 ' P>: I October 21, 1944. To: Governor Ransom From: Yrs. Cagle and 11r. Robinson Subject: Use of Federal Reserve credit as borrowed invested capital to reduce or eliminate the income subject to the excess profits taxes. We have already called to your attention and passed on for George Vest's review the fact that regulations of the Bureau of Internal Revenue require that "...indebtedness included in borrowed capital must be bona fide. That is, it must be incurred for business reasons and not merely to increase the excess profits credit." The extent to which banks are subject to excess profits taxes is difficult to judge. The reports of earnings and dividends filed with the supervisory agencies are not parallel in some details with those required for tax purposes so our findings are necessarily tentative. It appears that not more than 100 banks incurred a liability for excess profits taxes on the income for the yeer 1943. Of these that incurred a liability very few had more than nominal amounts. For the year 1944, the number may be about twice as great due not only to the larger earnings hut to the exhaustion of the unused excess profits credits for the two previous years. The tax falls mainly on the very large banks. In the case of small banks (those with less than 5 million dollars of deposits) the invested capital credit appears to be adequate to protect them from the excess profits tax. LO 1 f , A. 1, ',";;Z:',VIV7-: f , m !rum;Er.cy.Ker. 0JAN -T Zg i 114/.1 - (V!) 7.3 vu-eLi( c-A-vj (Arr--q 130, Q:tp1'1( r ) roil 1-i. ts.,, ocricocci • 1. October 23, 1944 To: From: Mr. McKee Anne I. Cotten Mr. Ransom asked me to send you a copy of memorandum dated October 21 from Mrs. Cagle and Mr. Robinson on the subject of "Use of Federal Reserve credit as borrowed invested capital to reduce or eliminate the income subject to the excess profits taxes," so that you would have an opportunity to consider it before the Board meets today to discuss a reply to Mr. Gilbert of Dallas on the matter that the Board discussed informally on Saturday. Attachment rre didri411 i,it it frr:F.4tixeill UCT 2 131244 -'-' . ...3 .-.., . 1 October 21, 1944 Memorandum: Mr. Gilbert, of the Dallas Bank, called Governor Ransom on the telephone this morning and said that one of the banks at Houston (the City National Bank of Houston) had offered the Federal Reserve its note for 30 million secured by short-term government obligations that it was buying in the open market. On yesterday this bank had used all its reserves, including cash and exchange, to make the purchase, so technically it came to the Federal Reserve on the basis of restoring its reserve. Mr. Gilbert said: "The bank has capital and surplus of inquired to find 21 million. Its deposits are i:i80 or $85 million. We n and find that it is to perout what was represented by this transactio mit some sort of tax saving on the part of the City National Bank. I think they have the option of reporting on actual income or invested capital basis. They feel that if they can set up a borrowing of 21 million dollars during the year, they mould need to borrow :i;30 million to do it. We handled the transaction yesterday and gave them credit for it, but I called a meeting of our discount committee yesterday afternoon, because I was not sure that that was proper use of Federal Reserve credit. I do not think that it is a transaction that comes within the scope of Section 4, because it does not represent speculation. They are buying Treasury certificates and a few notes, all maturing within eight of ten months. As a result of our discussion yesterday, several things developed. In view of the statement of the three supervisory agencies, made in 1939, we do not want to let anybody get the impression that we are not milling to lend freely on government securities at par. Also, the Treasury is interested, because of creating a lack of confidence in securities. But there is a Federal tax question involved - an income tax question. "Here is what we think we should do, and it is a rather delicate matter and might le regarded as something that should be passed on by the Board, because the System might te involved. If this transaction has merit, other banks might want to do it. It would simply result in reducing our holdings of government securities in the open market account and putting them back of loans in Federal Reserve Banks -- that would be the net result so far as federal funds are concerned. We feel that we should talk to the bank and tell them that we dot if that is proper use of Federal Reserve credit and ask them to take steps to unwind the situation. We felt that we had to approve it yesterday, because the bank had purchased the securities and wanted the loan to secure its reserves. I think we should discuss it on the basis that it is not the proper use of Federal Reserve credit; they have not lost deposits, are not increasing their loans in any way; that it is an artificial transaction permitting them to effect a tax saving, and actually they are going ahead with a borrowing program in order to create a 2i million yearly average borrowing. . .1 ; . — \ • FILFOii — 2 Gladys Glover tfri -2"I felt that for the day, however, we should accept the discount, which we did. Then we got to talking about it among ourselves and the more we thought about it, the more we were in doubt about whether it was a proper use of Federal Reserve credit, but in view of the government securities involved and the statement made about Federal Reserve discounting on Government securities at par, I wanted to check with the Board before we take the matter up with the bank. I would like an answer by Monday if possible, as I think there is a question of principle involved that we would like to have cleared up. "That borrowing is equal to 12 times the bank's capital and surnlus and equal to about 1/3, or a little more, of its deposits, and under the law it could not engage in any such borrowing transaction except with Federal Reserve Banks, because it would be liaited to the amount of its capital structure in its borrowing. "They exhausted their reserve with the purchase of the securities and now they are restoring the reserve by this borrowing." AC
@FedFRASER